Private Mortgage Insurance: How It Works & How to Avoid It
Private Mortgage Insurance: What It Is, How It Works, and How to Avoid It. Private mortgage insurance (PMI) is a type of insurance that some lenders require you to buy if you take out a conventional loan with a down payment of less than 20 percent of the home's purchase price.
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PMI protects the lender, not you, in case you stop making payments on your loan. PMI can add to your monthly mortgage payment and increase the total cost of your loan. In this article, we will explain what PMI is, how it works, and how to avoid it.
What Is PMI and How Does It Work?
Private Mortgage Insurance - PMI is an insurance policy that covers the lender's loss if you default on your loan. PMI is usually required for conventional loans, which are loans that are not insured or guaranteed by the federal government, such as FHA, VA, or USDA loans. PMI is typically paid as a monthly premium that is added to your mortgage payment. The amount of PMI you pay depends on several factors, such as:
- The loan amount: The higher the loan amount, the higher the PMI.
- The loan-to-value ratio (LTV): The LTV is the percentage of the home's value that you borrow. The higher the LTV, the higher the PMI.
- The credit score: The lower the credit score, the higher the PMI.
- The loan term: The longer the loan term, the higher the PMI.
- The type of loan: Some types of loans, such as adjustable-rate mortgages (ARMs), may have higher PMI than others.
The cost of PMI can vary from 0.5 percent to 2 percent of the loan amount per year, according to NerdWallet. For example, if you borrow $200,000 with a 10 percent down payment, a 30-year fixed-rate loan, a 4 percent interest rate, and a 700 credit score, you may pay about $80 per month or $960 per year for PMI, according to Bankrate's mortgage calculator.
PMI is usually canceled automatically when your LTV reaches 78 percent, which means that you have paid off 22 percent of your home's value. You can also request to cancel PMI when your LTV reaches 80 percent, which means that you have paid off 20 percent of your home's value. However, you may have to meet certain conditions, such as having a good payment history, having no other liens on the property, and providing evidence of the home's value, such as an appraisal.
Why Should You Avoid PMI?
Private Mortgage Insurance - PMI is an extra expense that can make your loan more expensive and reduce your home equity. Here are some reasons why you should avoid PMI:
- PMI does not benefit you: PMI only protects the lender, not you, in case you default on your loan. PMI does not cover your mortgage payments, your property taxes, your homeowners insurance, or your home repairs. PMI also does not prevent foreclosure, which is the legal process of the lender taking over your property if you fail to repay your loan.
- PMI can be hard to cancel: PMI is usually canceled automatically or by request when your LTV reaches a certain level, but some lenders may make it difficult or costly for you to do so. For example, some lenders may require you to pay for an appraisal, which can cost from $300 to $500, to prove the home's value. Some lenders may also charge a fee or impose a waiting period for canceling PMI.
- PMI is not tax deductible: PMI used to be tax deductible for some borrowers, but the deduction expired at the end of 2022 and has not been renewed by Congress. This means that you cannot deduct PMI from your taxable income, unlike the interest that you pay on your loan.
How to Avoid PMI?
There are several ways to avoid Private Mortgage Insurance - PMI, such as:
- Making a larger down payment: The most common and straightforward way to avoid PMI is to make a down payment of at least 20 percent of the home's purchase price. This will reduce your LTV and eliminate the need for PMI. However, this may not be feasible or desirable for some borrowers, as it may require a large amount of cash and delay your home purchase.
- Taking a piggyback loan: A piggyback loan is a second loan that you take out in addition to your primary loan. The piggyback loan covers part of your down payment, such as 10 percent, while your primary loan covers the rest, such as 80 percent. This way, you can avoid PMI by having a combined LTV of 90 percent or less. However, a piggyback loan may have a higher interest rate, a shorter term, and additional fees than your primary loan, which may make it more expensive and risky.
- Choosing a lender-paid PMI: A lender-paid PMI is a type of PMI that is paid by the lender, not by you. The lender pays for the PMI upfront or over time, and in exchange, charges you a higher interest rate on your loan. This way, you can avoid paying PMI as a separate monthly premium, but you may end up paying more interest over the life of the loan. You also cannot cancel a lender-paid PMI, as it is built into your interest rate.
- Applying for a government-backed loan: A government-backed loan is a type of loan that is insured or guaranteed by the federal government, such as an FHA, VA, or USDA loan. A government-backed loan may have lower or no down payment requirements, which may allow you to avoid PMI. However, a government-backed loan may have other costs and fees, such as an upfront mortgage insurance premium (UFMIP) or a funding fee, which are similar to PMI but may be more expensive or harder to cancel.
Read Also - Mortgage Loan 101: What You Need to Know Before You Apply
Conclusion
Private Mortgage Insurance - PMI is a type of insurance that some lenders require you to buy if you take out a conventional loan with a down payment of less than 20 percent of the home's purchase price.
PMI protects the lender, not you, in case you stop making payments on your loan. PMI can add to your monthly mortgage payment and increase the total cost of your loan. Therefore, you should try to avoid PMI by making a larger down payment, taking a piggyback loan, choosing a lender-paid PMI, or applying for a government-backed loan.
In this article, we have explained what PMI is, how it works, and how to avoid it. We hope that this article has helped you understand and appreciate the PMI, and how to use it to achieve your home loan goals. We also hope that this article has provided you with some practical and useful advice and resources that you can use to make informed and smart decisions about your PMI.
If you want to learn more about the PMI, or if you need more help or guidance, you can visit some of the following websites or links that we have provided in the article:
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- What Is PMI? How Private Mortgage Insurance Works - NerdWallet: A website that provides a comprehensive and user-friendly guide on the PMI, such as the cost, the cancellation, and the alternatives.
- Mortgage Calculator | Bankrate: A website that provides a simple and easy mortgage calculator, with options for property taxes, homeowners insurance, and mortgage insurance. It also shows the amortization schedule and the best Boydton mortgage rates for Nov 29, 2023.
- What is private mortgage insurance? - Consumer Financial Protection Bureau: A website that provides a brief and clear explanation of the PMI, such as the definition, the requirement, and the cancellation.
- What Is Private Mortgage Insurance (PMI) And How Does It Work?: A website that provides a lot of information and advice on the PMI, such as the types, the cost, the benefits, and the drawbacks.
- What Is Private Mortgage Insurance (PMI)? | Bankrate: A website that provides a detailed and informative article on the PMI, such as the cost, the cancellation, and the alternatives.
Thank you for reading this article, and we hope that you have found it helpful and informative. Please feel free to share your feedback, comments, or questions on the article, or to contact us for more information or assistance. We wish you all the best in your home loan journey! blush