Prior to the recession, many homeowners were able to take advantage of generous lending options that often included financing as much as 100 percent of a home’s value. While this is great for a potential homebuyer who doesn’t have the money for a large down payment, it was risky for lenders. When the recession hit and home values dipped, homeowners without any equity found themselves in trouble, and in many cases lenders lost money from homes that were ‘underwater’. To remedy this situation, lenders now require the purchase of private mortgage insurance, or PMI, to protect against losses.
Who Pays PMI?
Any buyer who purchases a home with less than a 20 percent down payment will pay for private mortgage insurance. If you end up in foreclosure, the money paid protects the lender from losing money. Regardless of whether you are purchasing a new home or refinancing an existing mortgage, if you have less than 20 percent equity, you will pay PMI.
How Much Does it Cost?
The fees for PMI vary depending on the size of your down payment, your credit score, and the lender, but most will fall between 0.3 and 1.5 percent of the original loan, paid out per year. PMI has been tax-deductible in some years, but not all, so talk to an accountant at the end of the year for clarification if you want to try and deduct it. As mentioned, the lender will calculate an annual premium based on the original cost of your loan, then that amount will be broken down into monthly payments and added to your mortgage payment.
How Long Do I Have to Pay PMI?
There are rules in place that specify that a lender must cancel your PMI automatically when the balance of your loan drops to 78 percent of the home’s original value, but since home loan are structured to pay a significant portion toward interest at the beginning of the loan, it may take some time to pay down 22 percent of the loan’s principal value. You can also speed up that process by requesting that your lender cancel the PMI when you have 20 percent equity in your home, rather than waiting until you have 22 percent and the lender must cancel it automatically.
In some situations you may be able to cancel PMI if home values rise significantly in your area, and/or if you refinance and you have at least 20 percent equity with the new loan. Talk to your lender about this to find out if you are eligible in these cases.
Are There Benefits to PMI?
Generally speaking, private mortgage insurance is designed to protect the lender in case you stop making payments on your home, but PMI can be beneficial to homeowners because it can allow you to get qualified for a loan that you would otherwise not be able to afford without a 20 percent down payment. It can also help you qualify for a loan at a lower interest rate than if you were to get a conventional loan with a low down payment and no PMI (those usually have higher interest rates). The trade-off is that you will be paying a higher monthly payment that includes PMI until you have 20 percent equity.
For some lenders, there are better options than conventional loans with PMI, so talk to a lender about VA loans or FHA loans, or see if there is someone who is able to lend you the 20 percent down payment that you can pay back over time.