If you want to avoid paying private mortgage insurance or PMI, you’re not alone. Buying a home requires a large wad of cash and saving money where you can makes absolute sense.
Unfortunately, having enough funds for the down payment is among the biggest struggles of many first-time home buyers. After all, fifty-seven percent of prospective home buyers believe that owning a home would be difficult with their current financial situation.
And for those who can’t afford the 20% down payment, paying the PMI provides a shortcut to buying a new home. We help you to understand how to calculate primary house loans and PMI.
Now, let’s talk about private mortgage insurance.
What exactly is PMI?
You’ve probably read about Private Mortgage Insurance or PMI if you’re planning to buy a home.
PMI protects the interest of lenders who finance borrowers who can’t afford the required down payment. When a borrower defaults on the loan, the insurance pays off a portion of the mortgage.
But even if the insurance company pays the lender, you will not gain a lot of benefits. The lender can still foreclose the property. And it won’t save your credit score from dipping.
While PMI reduces the risk of default for lenders, the greatest benefit you’ll get is this — buying the property with a low down payment. And, if you’re qualified, you’ll get an additional home owner tax deduction for PMI premiums paid at least until 2020.
Even if you’re paying money to protect the lender’s interest, many home buyers are still willing to pay for it. In fact, about 41% of agency-backed mortgages are covered with PMI.
How much does Private Mortgage Insurance cost?
The average annual cost of PMI is between 0.5 to 2% of your loan amount. This means that if you have a $300,000 mortgage, you would be paying between $1,500 to $6,000 per year that’s $125 to $500 per month.
The actual cost of your PMI could also depend on factors like the following:
- Loan amount. Your PMI will increase as your loan amount increases.
- Loan type. Adjustable-rate mortgages where the rates can go up depending on market trends require higher PMI compared to a fixed-rate mortgage.
- Credit score. Borrowers with a good credit score will pay less PMI than someone with a low credit score.
- Down payment. The higher the down payment is the lower the PMI.
How do you pay the PMI?
Most borrowers pay their PMI premiums every month along with their loan amortization. But some lenders give you the option to pay the PMI upfront.
Sometimes, you can pay part of the premiums upfront and pay the balance monthly.
Then there’s also something called the lender-paid mortgage premium insurance. Here, the lender will shoulder the cost of your mortgage insurance premium.
With this arrangement, most borrowers end up making lower mortgage payments. On the downside, you can’t cancel lender-paid mortgage premium insurance.
There are also lenders that allow borrowers to buy insurance from a third party. In this case, you have to pay for the cost of the premiums upfront.
Do I need to pay PMI for a government-backed loan?
Government-backed loans have their own version of the private mortgage insurance.
USDA and FHA loans require borrowers to pay for Mortgage Insurance Premium or MIP.
MIP for FHA loans actually cost more than the PMI for conventional loans.
If you apply for an FHA loan, you have to pay the 1.75% upfront fee based on the loan amount. On top of that, you have to make annual payments which could range from 0.45% to 1.05% of the loan amount.
For USDA loans, there is an upfront MIP of 1% and the annual cost is 0.35% of your loan amount.
VA loans, on the other hand, require another version called the funding fee which depends on how much your down payment is.
If your down payment is 10% or more, the funding fee is at 1.4%. The fee increases to 1.65% if your down payment is 5% or more but less than 10%.
For down payment amounts below 5%, the funding fee increases to 2.3% for first-time borrowers and 3.6% for other borrowers.
Do I have to pay PMI until I pay off the loan?
While PMI is an additional cost to a borrower, it is not permanent. You can cancel PMI but it usually takes two years before you can cancel your PMI.
Here are three ways to cancel your PMI.
Method #1: Request for cancelation when your equity is almost at 20%
You can request the cancelation of your PMI once you have at least a 20% equity in your home. Most of the time, lenders require borrowers to make the request in writing. They may also request another appraisal to check if the property value did not decline.
Lenders won’t approve the cancelation unless your mortgage is current. You should also have no second mortgage on the property.
Method #2: Wait until your principal balances reach 78% of your property’s original value
Even if you don’t cancel your private mortgage insurance, your lender still needs to do it on your behalf once the loan balance drops to 78% of the property’s value.
You also need to meet another condition –your account should be current. If it’s not, you need to update your mortgage first. Your lender should approve the cancelation once you pay all past due balances.
Method #3: Stay current until the midpoint of the loan’s amortization schedule
If you’re paying your loans regularly, your lender may also cancel PMI once you reach the midpoint of your loan amortization.
So, if your mortgage has a 30-year term and you’ve paid for 15 years, you can cancel your PMI even if you don’t meet the 78% requirement. This treatment is mostly applicable to interest-only loans.
Method 4: Refinance your mortgage
Another approach you can take is to refinance your mortgage. This strategy works best if you qualify for a loan with a lower interest rate and your new loan amount is no more than 80% of the property’s home value.
When you meet all the conditions, you can refinance the loan to avoid PMI and reduce your mortgage payments as a whole.
How can I avoid paying PMI?
Lenders require PMI when you can’t afford the 20% down payment but there’s a workaround. Instead of just applying for a mortgage, apply for a smaller loan to cover the down payment. The smaller loan will carry a higher interest and you have to pay it on top of the mortgage.
Known as piggybacking, this practice may be a cost-effective option. Even if there are two loans, you can still deduct the interest rate on your tax return if you itemize.
Paying PMI Makes the Most Sense for Some Buyers
PMI is an additional cost for any home buyer. If your priority is to buy now to avoid rising costs, paying for this insurance may be the most practical option.
By factoring inflation, you may see greater savings now even with your insurance premiums.