Navigating the road to homeownership can sometimes feel like deciphering a complex map with numerous checkpoints along the way. One of the key concepts you may encounter on this journey is private mortgage insurance, commonly known as PMI. Understanding what PMI is, how it works, and whether you need it is crucial for making informed decisions about your home purchase and managing your mortgage effectively.
Private mortgage insurance (PMI) is a type of protection that lenders require from most homebuyers who obtain loans that are more than 80 percent of their new home's value. In other words, buyers with less than a 20 percent down payment are normally required to pay PMI. This insurance protects the lender in the event that the borrower defaults on the loan and the home goes into foreclosure.
When you opt to put down less on a home purchase, you're considered a higher risk to the lender. This is because the loan amount is larger relative to the property value, and there's less equity or ownership built up in the house. The lender seeks the safety net that PMI provides to ensure they'll recoup some of their investment even if the loan isn't paid back in full.
PMI typically involves a monthly premium added on to your regular mortgage payment, although there are other payment options available as well. The cost of PMI varies based on the size of the down payment and the loan, but it typically ranges from 0.3 percent to 1.5 percent of the original loan amount per year. Considering this additional cost is essential when budgeting for your home.
Can you avoid paying PMI? Yes, if you save enough to make a down payment of at least 20 percent of the purchase price of your home. However, amassing that level of savings can be a significant hurdle, particularly in markets where home prices are steep. As such, many buyers opt to pay PMI in order to buy a home sooner rather than waiting years to save up a larger down payment. Another way to avoid PMI is by taking out a piggyback loan, where the homebuyer takes out a second, smaller mortgage to cover part of the down payment.
The good news is that PMI doesn't last forever. Once you've built up enough equity in your home—typically 20 percent—you can request that the lender cancel the PMI. Moreover, federal law requires lenders to automatically terminate PMI when the mortgage balance reaches 78 percent of the original value of the home, provided the borrower is in good standing.
Now, let's talk about when PMI might be a good idea. If you're looking to get into the housing market sooner rather than later, and you've found a home that you love but don't have the full 20 percent down payment saved, PMI allows you to move forward with the purchase. Additionally, it could make sense if you expect your home to appreciate quickly, or if you plan on making improvements that will increase its value, thereby reaching that equity threshold faster.
On the flip side, if you can wait and save up a larger down payment, or if you find a way to secure a loan with a lower down payment requirement without PMI (like through some government-backed loans), you may decide to go that route and skip PMI altogether.
In conclusion, private mortgage insurance is an extra cost homebuyers may face when they are unable to make a substantial down payment. While paying PMI can add to the expense of your mortgage, it also opens up the possibility of owning a home sooner rather than later. Carefully consider your financial situation, your long-term housing plans, and the current housing market to make the decision that's right for you. Remember to keep track of your home equity, as you may eventually be able to shed this additional expense, reducing your overall mortgage payment.
The deciding factor should always be based on a balance between your immediate housing needs and your financial plans for the future. With a strong understanding of PMI and its impact on your mortgage, you can navigate the path to homeownership with confidence and clarity. Whether PMI is a stepping stone in your home buying process or something to bypass entirely depends on your unique circumstances, but now you're equipped with the information needed to make that choice.
This article was contributed on Aug 22, 2024
