What is Private Mortgage Insurance?
Private Mortgage Insurance, or PMI, is an insurance policy that pays out to a lender in case a homeowner defaults on a mortgage.
The homeowner pays a monthly or one-time premium on their mortgage payments, but the lender is the one getting the protection.
PMI is usually requested for and arranged by the lender, and is offered by private insurance companies. Lenders usually request PMI if the homeowner wishes to put less than a 20% downpayment on the house, and usually require the policy to be in place until there is at least a 20% Loan-To-Value, or LTV ratio on the house. The LTV ratio is calculated simply by taking the value of a loan on a house and dividing it by the value of the house. For example, if a house is worth $100,000, and the loan amount is $90,000, the LTV ratio on the house is 90%.
PMI rates range commonly from .3% to 1.5%, depending on the size of the loan, the size of the down payment, and the buyer's credit score.
How would I, as a homeowner, pay for PMI?
Lenders offer different choices to homeowners as to how to pay for PMI.
- The most common way to pay for PMI is a monthly payment added onto your mortgage payment.
- Many lenders also offer a single payment, paid as an up-front premium at closing.
- Some lenders may require both a monthly payment and an up-front premium.
Ask your lender what options they offer before agreeing to a mortgage, and talk to a loan officer to help you calculate the total cost of the different payment options.
What are the benefits of PMI to me as a homeowner?
PMI allows you to pay a far smaller down payment on a home. If a homeowner takes a PMI policy, some lenders offer down payments as low as 3%.
Without PMI, lenders will usually require a down payment of at least 20%. With the housing market raising in value, the average price of a house in the US is nearing almost $400,000. A 20% down payment of $80,000 would take many people years to save up. Having liquid cash on hand allows a homebuyer to make other invesments or pay for the other up-front costs of being a new home owner.
Getting a home earlier can save you more money than PMI would cost.
Many people forego buying a house because they don't want to pay the PMI premium. In today's world, with the ever raising housing market, buying a home earlier, even if it means paying for PMI, can save you money. In 2011, an average home sold in the US cost $259,700. In 2018, an average home in the US sells for $374,700. If a homebuyer decided to buy a house back in 2011, opting to pay for PMI, rather than saving up for a larger down payment, they would have profited tens of thousands of dollars on their home, as their house would have appreciated over $100,000, but the cost of PMI would have likely been under $10,000. A homeowner who is also trying to save up enough for a 20% down payment also need to consider the rising prices, as they would need to save up to 20% of the current value of the house, which can take them longer and only cost them more.
PMI likely lets you qualify for a loan you might not be able to get without it.
Agreeing to pay for PMI is usually enough to persuade lenders to give you a larger loan, as they are confident that, even if you default on the loan, they won't lose their money.
What are the negatives of PMI that I need to watch out for as a homeowner?
PMI costs homeowners hundreds of dollars a month but gives the homeowners no immediate benefits.
Lenders are the only ones that gain protection from a PMI policy. For a homeowner, it can feel (and almost is) as if they are just throwing money away. To top it off, PMI is no longer tax deductible starting in 2018, costing homeowners even more. This money could be put into an investment or used for other, more immediate, payments a new homeowner has.
A homeowner can be stuck paying for PMI for an extremely long time, having an extra monthly payment looming over them for years.
PMI contracts are difficult to cancel, and may need a formal request to cancel and a re-appraisal of the home before the contract ends, even if you have a 20% LTV ratio on your home. A PMI contract is not terminated automatically until a homeowner hits a 22% LTV ratio on their home, forcing the homeowner to pay for even longer than expected. Some contracts will also not take into account the equity owned, and will simply require a homeowner to pay for a specified time, even if they hit the 20% LTV ratio.
Do I have any options other than PMI if I want to have a down payment of less than 20%?
PMI is not the only way to avoid having to pay a down payment of 20% or above.
Homebuyers can look at what is called a "piggy-back" mortgage, where they can take out 2 loans, one with a lower interest rate for the value of most of the home, and another, smaller one, for the value they need to reach a 20% down payment. The most common type agreement is an 80/10/10 agreement, where a homebuyer takes out 2 loans, one for 80% of the value of the house, and one for 10%. With 10% of the value in the house in cash, combined with the 10% loan, they can reach the 20% down payment value and avoid having to pay PMI.
This solution will almost always give a lower initial payment than PMI, but that second loan will carry a higher interest rate than the first and cannot be eliminated until you fully pay it off, which could take years longer than eliminating PMI.
Is PMI the right choice for me?
PMI isn't the right choice for all buyers, but home buyers should consider it before automatically refusing it.
Taking a "piggy-back" mortgage could be the better choice for some buyers, giving them a lower monthly payment that might be more manageable while still allowing them to keep their down payment under 20%.
If you aren't able to come up with a 20% down payment on a home or believe that you can spend that money in better ways, calculate your options based on how you believe the real estate market or other investments will develop and the time you believe it will take you to reach 20% LTV ratio.
Many calculators, such as this PMI calculator can give you an idea of how much you would be paying monthly.
AS A WARNING:
PMI does not protect you. It only serves to protect the lender. If you fall behind on your payments, whether for PMI or on your home, you risk losing your home to foreclosure.
If you are in need of a mortgage broker that you can trust, we have some people we recommend here at Tom Crimmins Realty. If you would like to inquire more, you can contact us at 718-370-3200 or you can visit our website at www.tomcrimminsrealty.com