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.
Let’s take a look at PMI, how it works, how much it’ll cost you, and how you can avoid it!
What Is Private Mortgage Insurance (PMI)?
Private mortgage insurance (PMI) is insurance coverage that homeowners are required to have if they’re putting down less than 20% of the home’s cost. Basically, PMI gives mortgage lenders some backup if a house falls into foreclosure because the homeowner couldn’t make their monthly mortgage payments.
Most banks don’t like losing money, so they did the math and determined that 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. So, to protect themselves, banks require buyers to pay an insurance policy—the PMI—to make up the other 20%.
How Does PMI Work?
PMI is a monthly insurance payment you’ll make if you put less than 20% down on your home. It’s not an optional form of mortgage insurance, like some other mortgage insurance plans you might have seen out there. Here’s how it works:
- Once PMI is required, your mortgage lender will arrange it through their own insurance providers.
- You’ll be told early on in the mortgage process how many PMI payments you’ll have to make and for how long, and you’ll pay them every month on top of your mortgage principal, interest and any other fees.
- You’ll stop paying PMI on the date that your lender has calculated that your principal balance on your mortgage reaches 78% of the original appraised value of your home. After this, the PMI stops, and your monthly mortgage payment will go down.
PMI in no way covers your ability to pay your mortgage—it’s protecting the bank, because they’re the ones lending you more than 80% of the sale price! Once you have to pay PMI, you’re stuck paying those insurance premiums to the bank whether or not you default and go into foreclosure.
How Much Does PMI Cost?
The amount you’ll pay every month for your PMI all depends on your lender and how much of a deposit you’ve put down on your home.
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For traditional mortgages that you get from your bank or a mortgage company, PMI premiums are calculated using your loan total and range from 0.55% to 2.25% of the loan or more.1
Let’s pretend you’ve bought a house for $250,000 with a 10% down payment:
|Home Bought For:||$250,000|
|Down Payment:||$25,000 (10%)|
|Total Loan Amount:||$225,000|
|Rate of PMI:||1%|
|Monthly PMI Premium:||$187.50 (1% of $225,000)|
|Annual PMI Premium:||$2,250|
You could pay the annual premium up front with your closing costs or split it into monthly payments over the first few years of your mortgage. But if you’re paying monthly, you’ll also pay some interest on that premium! You can find out how PMI will impact your mortgage with our mortgage calculator.
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 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 altogether.
Finding a way to lower or avoid PMI just makes sense. Our example shows PMI charged at only 1% of the total mortgage. Many companies charge more—up to 2.25%—and those higher premiums could mean you’d spend more than $5,000 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.
How to Get Rid of PMI
Now, for some good news! There are a couple of things you can do to say goodbye to PMI.
1. Pay Extra on Your Mortgage Every Month
You could overpay on your mortgage every month and reach the point that you owe 80% or less, faster. That could get pretty tricky, though, because you’d have to find the extra cash every month.
But let’s take our example above and pretend you are able to pay off an extra $25,000 in a few years. Why not wait to buy the house and save up for a year or so? You could then buy that $250,000 dream home, be able to put down a 20% deposit, and avoid PMI completely!
2. Get a New Home Appraisal
Keep track of your home’s value! If it ends up being worth more than it was the year before (because more people are moving to the area, for example), this means more equity in your name.
Ask for a new appraisal from your lender if you think your home value has risen enough to boost your equity to more than 20%. As long as you owe less than 80% of the new appraisal, you can write to your mortgage lender and request to end PMI.2 But it’s up to you to pay for the new appraisal and follow the proper steps when asking your lender to end PMI early.
Having your home appraised after a few years, along with paying a little extra in mortgage payments every month, could get you to that magical 80/20 threshold much faster—and that equals big savings!
How to Avoid PMI Altogether
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 can be when you pay cash for your house!
But if you’re not quite there yet, you can still avoid PMI by putting down 20% or more of your future home’s cost. This might mean holding off on the house search until you’ve saved enough for that down payment, but think of the money you’ll save by avoiding PMI!
We know the mortgage process can be a minefield, but you don’t have to go through it alone! Working with a trusted mortgage company will give you peace of mind, knowing 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.