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The Ins and Outs of Private Mortgage Insurance

Can’t come up with 20% for a down payment? Be prepared to pay for private mortgage insurance (PMI).

Borrowers who are applying for a conventional mortgage and aren’t able to come up with a sizeable down payment towards a home purchase will have this additional fee tacked onto their mortgage payments. This is in addition to others like interest, escrow and taxes.

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PMI: Protecting the Lender

The more money you’re able to put towards the purchase price of a home, the less money you will have to borrow from your lender. The smaller that amount, the less risk you present to your lender in terms of defaulting on your mortgage.

On the other hand, the larger your loan, the higher of a perceived risk you’ll be to your lender. That’s where PMI comes into the picture: to protect the lender against any potential future loan defaults.

At the time of default, the lender will receive the difference between the market value of the property and the outstanding loan balance, up to a certain limit.

Used with conventional loans that are not backed by the government, PMI is arranged by your lender and offered by mortgage insurance companies. While it’s an added expense, it’s also a good thing for you if you can’t come up with at least 20% of the purchase price of your home through a down payment. Otherwise, you’d have a tough time qualifying for a conventional home loan.

How Much Does PMI Cost?

Just like all the other fees and expenses you need to cover when buying a home, you’ll need to factor in PMI costs in order to budget accordingly. But how much you pay will depend on a few factors, including the type of mortgage you’re applying for, the length of the loan, and the amount of your down payment. Generally speaking, you can expect to pay approximately 0.5% to 1% of the entire loan amount.

Let’s say the value of the home you buy is $300,000, for instance, and you put in a 10% down payment. Your PMI payments would be about $112.50 per month, assuming a 0.5% PMI fee. That’s not exactly chump change, especially when you factor in all the other fees you’ll be responsible for paying to operate your home.

It’s important to note that PMI payments don’t reduce your loan balance, nor are they tax-deductible like mortgage interest is.

PMI is Removed Once You Owe Less Than 80% of Your Home’s Value

The good news is, you won’t have to pay PMI forever, as long as you’re able to put enough money towards the principal to owe less than 80% of your property value. You’ll have to ask the lender to cancel PMI once you’ve reached this amount, as it’s not exactly automatically stopped. The PMI cancellation request needs to be made in writing, and you need to be current on your mortgage payments. Some home loans also have a minimum wait time – generally two years – before PMI can be canceled.

Once the loan balance drops to 78%, the lender is required to get rid of PMI. In fact, your lender is legally obligated to tell you at mortgage closing how many years and months it’ll take you to pay down your loan to have your mortgage insurance canceled.

But there are other ways to get rid of PMI. For starters, you could order a new appraisal if you believe your home’s value has increased to the point that you owe less than 80% of it’s worth. If you’ve made improvements to the property since buying it, you likely have increased its value. Keep in mind that appraisals will come at a cost of anywhere between $300 to $500.

You could also prepay on your loan, if your lender allows it. Even an extra $50 per month can translate into a significant reduction in your loan amount over time.

The Bottom Line

It’s easy to understand why lenders would want to protect themselves against the potential of loan defaults, especially when you consider what happened during the chaotic housing crisis in 2008. But you don’t have to be a slave to PMI. You can avoid it altogether if you can save up at least 20% of the purchase price of the home, or at least get rid of it some time in the future as your equity build ups. The sooner you can get it off the books, the more money you can free up to put towards paying down your mortgage principal.