Not all homebuyers can make a 20 percent down payment when taking out a mortgage. If you are putting down less than 20 percent, you will normally be required by your lender to purchase private mortgage insurance, or PMI. While it may seem like just an added expense you’d want to avoid on principle, PMI can get you into a house faster by allowing you to purchase with a smaller down payment—or no down payment at all. Let’s take a closer look at the details.
What Is PMI on a Mortgage?
Private mortgage insurance is an insurance policy that shields lenders from losing money if a borrower defaults on their loan. It’s generally required by lenders of homebuyers who get loans with low down payments or who don’t have good credit. It’s usually paid for by the borrower.
The cost of PMI depends on several factors, including the size of your down payment and the length of your loan term. However, according to Nerd Wallet, you can expect PMI to cost between 0.58 and 1.86 percent of the original loan amount each year. Private mortgage insurance is usually paid for in monthly installments alongside your monthly loan payments.
Sometimes, borrowers are required to pay mortgage insurance for the life of the loan, but this isn’t always the case. You can typically apply to stop paying for PMI when you’ve built up enough equity in your home (usually 20 percent). This can be accomplished through a number of methods (more on this to follow). Often with conventional loans, the lender will cancel PMI automatically once you’ve reached 22 percent equity. Your loan agreement may also provide for automatic cancelation based on your repayment schedule.
How to Get Rid of PMI
If your private mortgage insurance isn’t set up to be removed automatically at any point during the life of your loan, you still have a couple of options to get it removed. First, once you reach 20 percent equity (or 80 percent loan-to-value ratio based on the original value of your home), you can apply to your lender to cancel PMI.
For example, if you pay off enough of the loan so that you have at least 20 percent equity in the property, you may be eligible to cancel your mortgage insurance. There are also some government-insured loans, such as FHA loans, in which borrowers are eligible to cancel their mortgage insurance after reaching a certain point in the loan term.
The other way to get rid of your PMI is to refinance into a loan without it. You’ll need to do a little research to find out if refinancing makes sense for you. Refinancing at a higher interest rate just to remove PMI payments might not be worth it, but if you can improve your terms or lower your interest rate and remove the PMI, it may save you hundreds of dollars each year.
What Are the Benefits of Removing PMI From Your Mortgage?
Canceling mortgage insurance can provide several benefits for borrowers. First, it can reduce monthly expenses since borrowers will no longer be required to pay mortgage insurance premiums. Second, it can help to increase equity in the property by freeing up additional funds that can be used to make principal payments. Finally, removing mortgage insurance can make it easier to sell or refinance the property in the future.
Borrower PMI vs. Lender PMI
Borrower-paid PMI is typically paid as part of your monthly mortgage payment. The amount you pay depends on the size of your down payment, your credit score, and the insurance company’s premium rate.
Lender-paid PMI is paid by the lender and is usually a one-time premium at the loan closing. The amount you pay depends on your loan amount, your credit score, and the insurance company’s premium rate.
The type of PMI you have will affect when it can be removed. Borrower-paid PMI can be removed when you reach 20 percent equity in your home. Lender-paid PMI is typically removed when you pay down your loan to 78 percent of the original value.
Alternatives to PMI on a Mortgage Loan
For many homebuyers, private mortgage insurance is necessary. However, there are some alternatives to PMI that can help you avoid this expense. One option is to take out a piggyback loan, which allows you to finance a portion of your down payment with a separate loan. Another option is to find a lender that is willing to offer you a non-PMI loan. These loans usually come with higher interest rates, but they can still be a good option for borrowers who want to avoid PMI.
If you’re planning to buy a home, be sure to compare the cost of PMI with the interest rate on a higher-down-payment loan. It may be cheaper to get a loan with a higher interest rate and pay PMI than it would be to get a low-interest rate loan with PMI.
Whichever route you choose, make sure to compare the costs and benefits of each option before deciding. It may be to your benefit to sit down with your lender to go over your financial situation and discuss the specific options available to you. A mortgage is likely to be one of the biggest financial transactions you make. Knowing the ins and outs can save you money.
So, what is PMI on a mortgage? It’s a valuable tool that can help you to achieve your homeownership goals. The home loan and refinance experts at Solarity Credit Union believe in making owning a home more accessible to everyone. That’s why they offer a variety of mortgage options both with and without PMI. Speak with a Home Loan Guide today to explore the possibilities.