PMI insurance (Private Mortgage Insurance), also known as private mortgage insurance, protects the lender if you default on your primary mortgage and the house goes into foreclosure.
When borrowers apply for a home loan, lenders typically require a down payment equal to 20% of the property’s purchase price. If a borrower cannot repay that amount, the lender will typically view the loan as a higher-risk investment and require the borrower to take out PMI insurance.
PMI insurance is typically paid monthly as part of the entire mortgage payment to the lender. As long as the borrower is current on their prices, the lender must pay off PMI insurance by the date the loan balance is scheduled to reach 78% of the home’s original value (in other words, when the principal comes 22%).
Alternatively, a borrower who has paid enough toward the principal amount of the loan (the equivalent of that 20% down payment) can contact their lender and request that the PMI insurance payment be waived.
The cost of PMI insurance
PMI insurance can cost between 0.5% and 1% of the total mortgage loan annually, raising a mortgage payment quite a bit.
Say, for example, you had a 1% PMI charge on a $200,000 loan. That fee would add about $2,000 a year, or $166 each month, to the mortgage cost. And a potential homebuyer might have to pay more, since according to Zillow, the median US home price was $282,000 in January 2020.
Key Information:
- Lenders require borrowers to pay PMI or private mortgage insurance when they can’t make a down payment on a new home equal to 20% of the property’s purchase price.
- PMI insurance can cost between 0.5% and 1% of the total loan amount annually and is usually included in the borrower’s monthly mortgage payment.
- A homebuyer can avoid PMI payments by taking out a smaller loan to cover the down payment in addition to the primary mortgage or by choosing to purchase a less expensive home.
This cost may be a good reason to avoid applying for PMI insurance, along with the fact that is removing insurance once you have it can be complicated. However, PMI insurance is crucial to buying a home for many people, especially first-time homebuyers who may not have saved the necessary funds to cover a 20% down payment. Paying for this insurance could be worth it in the long run for buyers eager to own their own homes.
How to avoid PMI insurance
Suppose a homebuyer does not have 20% down payment funds. In that case, it is possible to avoid PMI insurance by taking out two smaller loans (usually with a higher interest rate) to cover the 20% down amount plus the primary mortgage.
This practice is commonly known as ” piggybacking. ” Although the borrower commits to two loans, PMI insurance is not required as the funds from the second loan are used to pay the 20% deposit. Borrowers can usually deduct the interest on both loans on their federal tax returns if they itemize their deductions.
Another option is to reconsider buying a home for which you don’t have enough savings to cover the deposit and instead look for a cheaper house that fits your budget.
Conclusions
PMI insurance can be an expensive necessity for homebuyers who don’t have enough money saved for a 20% down payment.
It is possible to avoid PMI by taking out the primary mortgage plus a smaller loan to cover the 20% down costs. For first-time homebuyers, PMI insurance represents extra money that will not be used for mortgage payments; however, many borrowers can deduct it (there are income limitations, and the deduction is not permanent, although it has been renewed through 2020). It is possible to eliminate PMI insurance once the borrower pays enough principal on the mortgage.