The Pros and Cons of Private Mortgage Insurance (PMI)
Private mortgage insurance is one of those controversial topics involved with buying a home. While some experts recommend avoiding PMI at all costs, others say it’s a price that’s more than worth paying to be able to get into a home sooner. What is private mortgage insurance? Known more commonly as PMI, this type of mortgage insurance is required when making a low down payment on a home. Should you actually take on PMI? This article covers the basics of PMI on conventional loans.
Why Do You Need PMI?
First, not everyone who buys a home needs PMI. If you are planning to put down 20% or more as a down payment when purchasing a home, you can completely ignore PMI because you won’t be required to pay for it by your lender. PMI costs are costs buyers take on when they want to be able to get into a home even though they haven’t yet saved enough for a 20% down payment.
When buyers purchase homes with less than 20% down using a conventional mortgage, they are required to pay for PMI in order to be approved for a loan. PMI is not an optional expense. The reason why lenders require PMI for down payments below 20% is because it protects them in the event that a borrower stops making payments on a loan. When mortgage insurance is needed for a Federal Housing Administration (FHA) single-family mortgage, it is called mortgage insurance premium (MIP) instead.
While MIP is similar to PMI, it requires a payment at closing. What’s more, monthly MIP payments will be due for the life of a loan if you put down less than 10% for a down payment. For borrowers who put down 10% or more with FHA loans, MIP vanishes after 11 years.
How Much Is Mortgage Insurance?
“While the amount you pay for PMI can vary, you can expect to pay approximately between $30 and $70 per month for every $100,000 borrowed,” according to information on PMI rate shared by Freddie Mac. How much is PMI usually? Like most types of insurance, PMI costs can fluctuate based on current insurance rates. However, most people are paying between 0.1% and 2% of their loan amounts annually. If you have a $400,000 mortgage, that could equal $8,000 per year.
Does Everyone Pay the Same Amount for Mortgage PMI?
Conventional loan PMI rates can actually fluctuate quite a bit by borrower. Your lender will take several factors into account when determining the cost for your PMI premiums. Here’s a look at what goes into the decision:
- Your Down Payment Amount: While PMI is for down payments under 20%, the exact amount you put down can determine how much you’ll pay for PMI. Many borrowers make the mistake of going as low as they can with their down payments once they know that they will be paying for PMI. Lower down payments are riskier for lenders. Increasing your down payment amount even if you can’t hit 20% can still help you save money by lowering your PMI rate.
- Your Credit History: When determining your PMI amount, your lender looks at your credit history to measure how responsible you’ve been when borrowing money in the past. A credit history that shows that you have a history of paying bills on time, paying back debt on time, and staying under your credit limit can help you to enjoy a lower PMI price than someone with a rocky credit history.
- Mortgage Type: PMI premiums are generally lower with fixed-rate mortgages compared to adjustable-rate mortgages. As a result, PMI premiums for fixed rates are generally lower.
- Your Lender: Cost of mortgage insurance is something to discuss with lenders while shopping around for your mortgage.
Like most aspects of getting a mortgage, PMI costs depend strongly on your financial history as a borrower. In addition, PMI is a cost that can fluctuate based on how much you put down even when you’re staying below 20% for a down payment. It may be advantageous to ask a lender to provide you with different quotes for PMI using different down payment amounts to decide when putting down just a little more money is worth it in the long run.
Is There a Type of Loan That Doesn’t Require PMI If You Put Down Less Than 20%?
The only loan that doesn’t have some type of mortgage insurance attached is a Veterans Affairs (VA) loan. While this loan type is only available to eligible veterans with an available home loan entitlement, this option allows buyers to purchase a home without down payments or monthly mortgage insurance. However, a one-time VA funding fee totaling between 1.25% and 3.3% of the loan amount may be required either at closing or as part of the loan amount. The funding fee is waived for veterans receiving VA disability and qualifying surviving spouses.
How Long Do You Have to Pay Mortgage Insurance?
PMI can disappear once a buyer has built equity of 20% in a home. Once you’ve reached that milestone, you will have to petition your lender to have your monthly PMI expense wiped away. However, PMI will go away even if you don’t take any action. Homeowners who are keeping current with their mortgage payments will see their PMI automatically terminate once the principal balance reaches 78% of a home’s original appraised value.
Is It Better to Pay PMI or Wait Until You Can Afford 20% Down?
This is a personal judgment call for the buyer. Generally, people view PMI as a vehicle for getting into a home sooner. PMI may be the right choice in the following scenarios:
- You’re worried about being priced out of the market if you wait.
- You want to be able to jump on a home because you’re shopping in an area with low inventory.
- You want to buy a home while interest rates are in a good place.
- You want to be able to look at a variety of homes and neighborhoods without worrying about coming up with 20% for a down payment.
- You want to get into a home soon because rising rental rates in your area will eat into any savings you’d get by skipping PMI.
- You think it will take years to save up a full 20% down payment.
- You’d rather make slightly larger monthly payments if it enables you to keep more cash now.
- You want to use a lower down payment because you’re saving money for home renovations or remodeling.
Of course, people who advise against PMI point out that it will take years to reach the threshold where PMI can be removed. They might also say that PMI is something that protects the lender instead of the buyer. You are essentially paying for an insurance policy every month that doesn’t protect your stake in what you’ve already paid into a home.
Is Private Mortgage Insurance the Same as Homeowner Insurance?
PMI is not related to a homeowner insurance policy. While homeowner insurance is required by lenders when obtaining a mortgage, it is not tied to your mortgage or down payment. Homeowner insurance policies cover damage to your home, property, or belongings due to weather events, fire, and other various factors. A policy is purchased through an independent insurance company that is not tied to your lender.
Is PMI the Same as Mortgage Protection Insurance (MPI)?
PMI and MPI are not related. MPI is a separate policy that you can purchase to have your mortgage payments covered after you pass away. Like life insurance, MPI ensures that your loved ones receive a benefit that can help them to avoid a sale or foreclosure. In fact, MPI is sometimes referred to as “mortgage life insurance.”
Final Thoughts on Private Mortgage Insurance
PMI can provide a much-needed shortcut to meeting the 20% down payment for borrowers who either aren’t able to save enough or prefer to keep more cash on hand for home repairs. However, PMI can be substantial on a larger mortgage. It’s also a cost that doesn’t technically provide any benefit or protection for the borrower beyond the smaller down payment due to the fact that PMI is intended to protect the lender instead of the buyer.
While PMI isn’t permanent, borrowers should carefully monitor the progression of their mortgages to ensure that PMI disappears when it should. Some lenders actually require borrowers to ask to have PMI removed even though they’ve reached the threshold for qualifying to have it removed.
Ultimately, deciding if PMI is smart comes down to crunching the numbers a few different ways to weigh slightly larger monthly payments against the perks of putting down less than 20% in the long run.