Congratulations, you’re ready to buy a home!
You understand the homebuying process.
You know how much mortgage you can afford.
You’ve even saved up money for your down payment.
But now your lender is saying you have to pay for private mortgage insurance?
Maybe you’ve heard of PMI- maybe you’ve even paid it on your mortgage loan- but what is it really?
How is it calculated?
And how can you avoid paying it?
Read on for the answers to these questions and more!
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What is PMI?
PMI stands for Private Mortgage Insurance.
PMI is a type of insurance that is required by conventional mortgage lenders when you put less than 20% down on your mortgage loan.
The goal of PMI is to protect lenders in case a homeowner defaults on the loan.
Generally PMI is paid alongside your monthly mortgage payment, but you can opt to make annual lump-sum payments instead.
The Good: Why should I pay PMI?
The good news is that PMI allows you to afford to buy a house without as much cash in your pocket.
If you live in a high-cost of living area, it could be nearly impossible to save a 20% down payment, even with a high income.
According to the National Association of Realtors, the median home sale price hit a record $341,600 in April 2021.
If you needed a 20% down payment for that home, you would have to save $68,000 – plus closing costs.
It may hurt paying extra money each month, but it makes home buying a lot more accessible.
The Bad: How is PMI calculated on a loan?
PMI ranges from .58% to 1.85 % of your total loan amount.
This means that you will generally pay $30-$70 monthly for every $100,000 borrowed.
This will vary based on your credit score (link) and your down payment.
If you put down 5%, your PMI will be higher than if you put down 15%.
Remember that your lender is charging you because they think you’re a risk- so they’ll charge you more depending on how risky you appear to be.
The Ugly: Why do people say that PMI is a waste of money?
PMI is the one part of your mortgage payment that doesn’t buy you anything.
Your principal payment reduces the amount of money you owe on your mortgage.
Your interest payment decreases the total amount of interest you owe.
Escrow covers your taxes and insurance, which allow you to live in your house.
Every month, PMI just pays your lender back for taking on an extra risk – without increasing their confidence in you over time.
This is why most people will tell you to avoid paying PMI if you can.
How can I avoid paying PMI?
There are a few ways that you can avoid paying PMI on your mortgage loan.
First, if you can put down a 20% down payment, you will not be required to pay PMI.
Easier said than done, right?
Some lenders offer low down-payment, PMI-free conventional loans – BUT you will pay a higher interest rate.
Some government-backed mortgage programs don’t require PMI, including VA loans.
When you’re getting preapproved for a loan, do some research and talk to your lender about possible options based on your current financial situation.
If none of these options work for you, consider buying a less expensive house that allows your down payment to cover a higher percentage.
How long do you pay PMI mortgage insurance on a conventional loan?
PMI doesn’t always last for the entire life of your mortgage – but, depending on the type of mortgage loan you receive, it can.
If you receive a conventional loan from your mortgage lender, your PMI should automatically fall off of your loan once you’ve reached 20% equity.
This means that once you’ve paid your mortgage down to 20% of your home’s value, your PMI should disappear.
I have heard stories of people having to call their lender multiple times to make this fee go away, so keep an eye on your mortgage balance and your timeline.
**Check the fine print on any mortgage to make sure that the bank guarantees this.
What about an FHA loan?
If you receive an FHA loan, you will be required to take mortgage insurance with the FHA.
Unlike PMI from a conventional loan, this mortgage insurance will NOT fall off automatically when you reach 20%.
The only way to get rid of PMI for an FHA loan is to refinance the entire loan once you have paid down 20% of your home’s value.
If rates have dropped since you got your loan, you could save a lot of money refinancing and removing your mortgage insurance.
But if rates have gone up, you’ll want to do some math to see if it will cost you more in the long-run to pay mortgage insurance or refinance.
Wrapping It All Up
PMI is private mortgage insurance that your lender uses to protect themselves against risk.
If you can’t put down a full 20% down payment on your mortgage, PMI can help you get a new home sooner.
However, it’s a charge that you have to pay for a long time.
If you can find ways to avoid paying PMI, whether it’s putting down a higher down payment or taking advantage of programs that don’t require PMI, you will save money in the long run.
And if you have to take out a loan with PMI, check your fine print to learn how to get rid of it.
Are you a homeowner or looking to become one? Are you paying PMI or planning on it? Do you have a plan to get rid of your PMI? Share your answers below in the comments!
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Sign up here to receive the FREE 7-Day Money Mindset Reset course!
