Lenders understand the challenges that come with the timing of your home purchase, especially in a highly active real estate market. And life events like a job change, marriage, or new baby may cause you to move forward with a home purchase earlier than intended. In these cases, private mortgage insurance (PMI) may be required to obtain a mortgage loan when a buyer’s down payment is less than 20 percent of the purchase price.
Who Benefits from PMI?
PMI helps home buyers purchase a home with a lower down payment. The lender benefits from reduced risks when PMI is attached to a mortgage loan; but as the home buyer, you must pay the premiums. As the beneficiary of the insurance policy, your lender is reimbursed for losses if you’re unable to make your monthly mortgage payment.
Home buyers can also benefit from PMI, especially in an active market when home pricing is on the upswing. Rather than waiting another year or two to save a higher down payment, buying early means benefiting from price appreciation and building wealth. In a rising real estate market, using PMI to buy at a lower price point gives you an advantage when the annual cost of a mortgage insurance policy is less than the annual increase in the market price of the home. The extra equity earned can be used to reach other financial goals, like buying a vacation home, funding your retirement, or adding to your kids’ college fund.
How is the Cost of PMI Calculated?
A careful analysis of the cost and benefits of PMI should be completed before you agree to purchase a policy. Annual premiums are typically added to your monthly housing payment, but sometimes all, or a portion of the premium, can be paid as an upfront cost. PMI is typically calculated based on the amount of the associated mortgage loan and the borrower’s credit score. Keep in mind the following factors:
A larger down payment will lower PMI premiums because the mortgage loan is a lower amount.
The amount of the mortgage:
Home buyers are insuring the amount they owe the lender. A larger mortgage means a greater potential loss for the lender; therefore, the PMI policy will cost more as well.
The borrower’s credit score will affect the cost of mortgage insurance premiums. It’s a good idea to pay down debt and work on improving credit before buying a home for a number of reasons, including a lower cost of PMI.
Generally, home buyers should anticipate spending between .55 and 2.25 percent of the total loan value on PMI each year, according to a research report from the Housing Finance Policy Center. A borrower with good credit and a mortgage loan of $200,000 might expect to pay anywhere between $1,000 to $2,000 per year, with monthly payments ranging from $83 to $167.
How Long Do You Need to Pay for PMI?
Once the mortgage balance falls to 80 percent of the home’s current value, the home buyer may request to discontinue PMI. There is usually a formal process to this discontinuation, such as a request in writing. If there is a significant change in the value of your home, your lender may also request a new appraisal before allowing you to drop PMI. Once the loan-to-value ratio falls below 78 percent, mortgage lenders are required to remove PMI from your loan.
Private mortgage insurance is one option to help home buyers purchase their dream home with a lower down payment. When home prices are rising, the cost of PMI may be offset by increases in your home’s market value. If you’re a first-time home buyer, you may wish to sit down with a qualified professional and gather information on borrowing options before making a final decision about which mortgage loan works best for you and whether it makes sense to purchase PMI.