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You’ve done your research, you’ve kept an eye on the housing market, and now it’s time to make an offer on your perfect home. As you move through the final steps of the mortgage approval process, you (and most other homebuyers) will probably encounter a new term: Private Mortgage Insurance, or PMI.
What Is Private Mortgage Insurance (PMI)?
PMI is pretty simple. Lenders don’t want to lose money on the mortgages they approve if a buyer can’t (or won’t) make their monthly payments. The banks did the math and determined they can recover about 80% of a home’s value at a foreclosure auction if the buyer defaults and the bank has to seize the house. To protect themselves, lenders require buyers to pay an insurance policy—the PMI—to make up the other 20%.
Does PMI safeguard your mortgage payment?
PMI premiums insure the bank against loss. They do not safeguard your mortgage payment. It can be easy to mix up because some mortgage companies also sell mortgage insurance. That type of insurance covers a buyer’s monthly payment if they can’t pay the loan because they lose their job, get sick, or other reasons. PMI essentially means the buyer pays the insurance premiums for the bank regardless of if they default on the loan or not.
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What most buyers don’t realize is that PMI can add hundreds of dollars a month to their mortgage payments. And PMI varies depending on the type of mortgage. If you’re considering an FHA, VA, or other non-traditional loan, beware! You’ll encounter costly PMI charges—and that’s just one of the reasons you should avoid those loans.
How much will PMI cost you?
For traditional mortgages you get from your bank or a reputable mortgage broker, PMI is pretty straightforward. Premiums are calculated based on the loan total and range anywhere from 0.5% to 1.5% of the loan. You can choose to pay the whole premium up front with closing costs, or you can split it into payments over the first few years of your mortgage.
Even though paying monthly means you’ll pay interest on the PMI premium as well, most buyers spread PMI over the course of their loan. Either way can be a costly choice. We’ll break down what would happen if you went this route with a $200,000 home and put $20,000 down.
|Property Taxes and Insurance (per year):||$3,050|
|Monthly Mortgage Payment (w/ PMI of 0.5% 26 months):||$1,630|
|Mortgage Payment (after PMI ends):||$1,555|
|Total PMI Paid:||$1,950|
So, you could be paying an extra $1,000 a year for the first two years of your mortgage to essentially insure the mortgage company. That’s more than 1% of the whole mortgage! You can see how PMI will impact your mortgage with our mortgage calculator.
Finding a way to lower PMI or avoid it altogether just makes sense. And the PMI in our example is only half a percent of the total mortgage. Many companies charge more—up to 1.5%—and those higher premiums could mean you’d spend more than $5,800 over two years! That’s money you probably don’t have (or want) to spend. Luckily, there are ways you can reduce or even eliminate your PMI costs.
Can I avoid paying PMI?
The easiest way to avoid paying PMI is to avoid a mortgage entirely by saving up and making Dave’s recommended 100% down payment. You’d be amazed at how affordable home shopping is when you pay cash for your house!
But if you’re not quite there yet, you can still reduce your PMI costs by putting more money down. Remember, your lender wants to make sure they don’t lose money if you default on your loan. And they know they can sell your house at auction for 80% of its appraised value. So, if you make a down payment of at least 20% ($40,000 in the case of our $200,000 home), you won’t have to pay PMI.
Before you get too upset about doubling your down payment, just think about how that means you could save as much as $6,000 in the first two years! That’s more than a quarter of the additional down payment—which means more money in your pocket in a relatively short amount of time.
When can I stop paying PMI?
In order to remove PMI from your monthly payment, you’re required to pay your mortgage down to 78% of the initial appraised value—the value of your house on the day the appraiser took a look at it. For that ideal home you bought at $200,000 with a traditional mortgage and 10% down, that means you will need to make 26 payments before you can kick PMI to the curb.
As soon as you’ve made the required number of payments, PMI stops, and there’s nothing else you need to do. But there is another way to make it end sooner.
Stop paying PMI sooner
Let’s go back to our $200,000 home/$20,000 down scenario from before. You know you’ll be paying PMI starting with your first payment. But how do you reduce what you’ll pay in PMI?
First, you can pay extra on your mortgage and reach that 20% threshold faster. With our example, that means you’d need to pay an extra $20,000 in the first couple of years. That’s a tall order for almost any budget! But really, if you’re able to pull off an extra $20,000 that quickly, why not wait a year or so until you can put the full $40,000 down and avoid PMI all together? It’s something to think about.
The second way you can reduce PMI expenses is to keep an eye on your home’s value. If your home is as good of a deal as you think it is, each year it’ll be worth a little more than the year before. And at the same time, you’re making regular monthly payments.
So, you can get a new appraisal if you think your home has crossed the 80/20 threshold mortgage brokers are looking for. As long as you owe less than 80% of the new appraisal, you can ask your mortgage lender to end PMI. But it’s up to you to pay for the new appraisal and ask the bank to end PMI early.
It’s definitely worth checking your current home value. Over the past few years, homes have been appreciating at more than 6.5% per year!(1) A $200,000 house this year could be worth $212,000 in just a few months. That’s an extra $12,000 in equity! Couple that with a little extra toward your payment each month, and you could find yourself at the magical 80/20 threshold much faster—and that equals big savings.
Is PMI Tax Deductible?
If you already have to pay PMI, there is a tiny silver lining (for now): PMI payments are tax deductible! The government really wants people buying houses. The deduction expired with the 2017 tax season, but Congress shuffled things around last minute and reinstated it for 2018.(2) Which means when it’s time to file your taxes, it’s possible your PMI paid could be tax deductible. The reinstatement was just for a year though, so it’s worth checking with the IRS in future tax seasons.
Deductions aside, the best option is just not having to pay PMI at all, and you know how to do that now! You’re ready to buy that house of your dreams, armed with the knowledge you’ll need to navigate the world of PMI.
Get the mortgage guidance you need
You don’t have to go through the mortgage process alone. Working with a reputable mortgage company will provide you with the peace of mind that you’re making the best decision with the best information available.
That’s why Dave recommends Churchill Mortgage to help you streamline the mortgage process, cut through the clutter, and stay on the path to winning with your finances. Take the next step and reach out to one of their mortgage experts today.