What is Private Mortgage Insurance (PMI)?
If you’re a home buyer making a down payment less than 20% of the home’s cost, you are required to have insurance coverage called Private Mortgage Insurance, or PMI. PMI provides a safety net for mortgage lenders in case the buyer couldn’t make their monthly mortgage payments and the home falls into foreclosure.
Banks require this because they typically can recover about 80% of the home’s value at a foreclosure auction in the event that a buyer defaults and the bank seizes the home. A PMI policy protects them from losing that remaining 20%.
How Does It Work?
If it’s required, your mortgage lender will work with their insurance providers to arrange your plan. This is a monthly payment, and you’ll be told how many payments you have to make and for how long. This timeline is determined by calculating how long it will take for your principal to reach 78% of the original appraised value of the home. These payments will be added on top of your mortgage principal, and when they stop your monthly mortgage payment will go down. You can choose to pay the annual premium up front with your closing costs to avoid paying interest on the premium.
It is important to understand that this insurance is protecting the bank, and you will still have to pay this insurance premium if you default or go into foreclosure.
Your PMI payment amount depends on your down payment, your lender, and the value of the home. The rate for a traditional mortgage could range from 0.55% to 2.25%, and sometimes more. A home bought at $225,000 with a 1% rate of PMI would have a monthly PMI premium of $187.50, or a $2,250 annual premium. PMI can vary and get expensive, costing thousands. Fortunately, there are ways to reduce or even eliminate PMI costs.
How to Reduce PMI
The sooner you pay off the first 20% of your principal, the sooner you can stop paying for PMI. This could mean overpaying your loan each month, but that is challenging. If you wait to buy the home and save that money for a down payment, you could avoid PMI entirely!
A new home appraisal could end your PMI early if the value of your home increases. More equity in your home could push the amount you owe below 80%, and you can then ask your mortgage lender to end PMI.
The Bottom Line
A 20% down payment is the only way to avoid PMI completely, so consider Private Mortgage Insurance costs carefully before buying a home. If you are ready to get started on the home buying process, apply now! As always, call, text, or email me today to learn about your options.