When applying for a mortgage, your lender may discuss the need for private mortgage insurance, or PMI. Because mortgage insurance adds to your total monthly housing payment, it’s a good idea to understand why you need to pay this additional cost and if a loan requiring an insurance premium is the best decision for you.
What is Private Mortgage Insurance?
Private mortgage insurance is one mechanism used to help buyers with lower down payments purchase a home. Lenders view potential buyers whose initial down payment is less than 20 percent as riskier than those with a larger initial payment. As such, lenders require private mortgage insurance for those mortgages. The insurance premiums will be included in your monthly housing payment, in addition to your mortgage payment and real estate taxes. If you should default on your mortgage before you reach the 20 percent equity mark, private mortgage insurance allows your lender to file a claim for reimbursement of the loan amount.
How Much does Private Mortgage Insurance Cost?
Private mortgage insurance premiums differ based on an individual’s credit score and the size of his or her down payment. A good credit rating means a better deal, said Michael Santos, a mortgage originator with AnnieMac in Mount Laurel, New Jersey. Santos noted in an interview that, for example, an applicant with an 800 FICO score will be offered a better rate than someone with a FICO score in the high 600s.
Bankrate.com states the range of premiums is 0.3 percent to 1.15 percent of the mortgage amount on an annual basis. For example, on a $100,000 loan, if PMI of .5 percent is charged, the housing payment would include an additional $42 per month to cover insurance premiums. Borrowers whose credit scores fall below a mortgage lender’s minimum requirement, or individuals offering lower down payments (as low as 3.5 percent) will need to apply for a Federal Housing Administration (FHA) loan and pay the mortgage insurance premium (MIP), which is the agency’s mortgage insurance program.
Private mortgage insurance premiums must be discontinued by a bank if borrowers have achieved 22 percent equity in their home and are current on their monthly mortgage payments. However, as soon as a borrower has 20 percent of their mortgage paid off, they may request that PMI be discontinued. Also, according to Santos, banks will often require an appraisal to ensure that the equity built equals at least 20 percent of the home’s current value. Because homeowners often bear the cost of the appraisal, you may prefer to wait until you are comfortably past the threshold before requesting the insurance be discontinued.
How Can You Avoid Paying Private Mortgage Insurance?
The best way to avoid PMI is to provide a down payment of 20 percent for your home. To achieve this, you may need to rent for an extra year or forgo a portion of your discretionary spending. However, if you would like to buy a home and are unable to save the full 20 percent of a house you think you can afford, consider a less expensive house whose 20 percent down payment will be covered by your current savings. However, if a 20 percent down payment does not work for you, mortgage lenders understand that market conditions or other personal situations may result in a buyer’s decision to purchase a home before he or she can pay a large down payment. In these cases, paying PMI may be the best, most efficient route to homeownership.