Private mortgage insurance (PMI) is a type of insurance that most borrowers are required to pay if they are not making a down payment of 20% or more. While you may think you understand the concept of insurance, if you have never bought a house before, you may not realize that PMI is different than most types of insurance. Here are five PMI facts every buyer should know:
1. PMI protects the lender, not the buyer.
Most insurance is something you buy to protect yourself – your car, your home, your health, etc. PMI is something you pay for but it actually protects the lender, not you. A 20% down payment has traditionally been the standard because if a borrower defaults and the lender must foreclose on the property, that 20% down payment will help the lender pay for the costs of repairing and selling the home. Without that full 20%, lenders are left open to large losses in the event of default. A private mortgage insurance policy insures the lender for so much money in case you are unable to pay your mortgage and the bank has to deal with the sale of the property. You pay the PMI premiums for the privilege of taking out a home loan with less than 20% down.
2. PMI increases your mortgage payment.
PMI premiums are usually divided by 12 months and added to your monthly mortgage bill. This could cost you an extra $30-$70 per month for every $100,000 you have borrowed for your home. In some cases, your monthly mortgage payment could be hundreds of dollars higher because of PMI.
3. You can get rid of PMI.
Most mortgages allow you to cancel your PMI policy when you gain 20% equity in your home. This can happen in two ways. First, your property value could grow over time, giving you extra equity without you having to do anything. Second, you could pay down your mortgage principal until you have paid down at least 20% of the loan. That could be through monthly payments or through a one-time lump sum.
4. PMI does not automatically get cancelled once your equity reaches 20%.
Just because you reach 20% equity in your home does not mean the lender will automatically cancel your PMI policy. Many mortgages will stipulate that the lender will contractually cancel the policy when you reach 22% in equity, but if you initiate the process, it can be canceled at 20%. So borrowers need to be vigilant in keeping track of their progress on mortgage principal and on how much the housing market prices have increased in order to get rid of PMI as soon as possible.
5. You can avoid PMI.
There are ways to avoid paying PMI. Of course, you could wait and save up until you have a 20% down payment. Sometimes that is not realistic. The other options include VA loans or Physicians loans if you qualify, piggyback loans or some nonconforming loans. With excellent credit, you may even be able to get a mortgage with no PMI from certain credit unions without putting 20% down.
6. FHA loans require PMI for the life of the loan.
FHA government mortgages have different requirements than private ones. Because they allow such low down payments, many FHA loans will require you to pay PMI for the life of the loan, which is typically 30 years.
Armed with these essential facts, you will can decide how and if you want to pay private mortgage insurance before you buy that first (or next) house.
Although paying PMI isn't fun, buying a home sooner and paying PMI often helps you buy a home much earlier (usually at a lower price) and helps you to begin to earn equity much faster.
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