PMI stands for Private Mortgage Insurance. The purpose of PMI is to protect the lender in the event you are unable to make your mortgage payments. PMI may be a requirement if you put less than 20% of the purchase price toward a down payment on a conventional loan. You may also want to consider PMI as a requirement if you are refinancing (again, with a conventional loan) and your home equity is less than 20%.
Also known as:SME Insurance, Private Mortgage Insurance
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Buying your first home is not easy. And for many millennials, home ownership they may cost more than they think.
This is because many new homeowners end up paying a additional commission on top of normal mortgage payments. This fee comes in the form of private mortgage insurance, or PMI, a form of mortgage insurance that can add significant costs to purchasing a home. It is a type of policy that protects the lender in the event that you fail to make your mortgage payments. While extra payments can help you get into your first home faster, it’s easy to get caught out.
“Most first-time home buyers don’t know about private mortgage insurance,” says Bill Banfield, executive vice president of capital markets for Quicken Loans.
Homebuyers are generally looking for private mortgage insurance when purchasing a home with less than 20% down. It is not insurance for you, the homeowner, but for your lender in case you default on your mortgage. The mortgage lender charges PMI based on the total loan amount and adds this cost to the homeowners’ monthly mortgage payments.
For example, the average Millennial starting home price in 2022 was $325,000, according to data from Realtor.com. If the first-time buyers’ down payment was 10% (or $32,500) and their 30-year mortgage loan is $292,500PMI costs would be averages around $150 a month, which varies depending on on buyers’ credit scores, loan-to-value and debt-to-income ratios. This equates to an extra $1,800 per year.
The great thing is that PMI doesn’t last the entire life of the loan and there are ways to get out of it. Here’s how to reduce or abandon PMI.
Save enough for a 20% down payment.
The most obvious way to avoid PMI from the start is to wait until you have the 20% down payment amount up front. But that could take years, and the rising value of homes in that market could keep potential buyers chasing the growing down payment frustrated.
A relative can also make a gift towards the balance to bring the down payment to 20%. There are some restrictions, but generally, if a buyer has a letter with these details, he will pass muster with the lender’s underwriters.
Reach 22% of real estate
When a buyer’s equity has reached 22% of the home’s original appraised value, the loan servicer is required to reduce the PMI. In many cases, however, homeowners can petition their lenders to drop PMI once it has accumulated 20% and 25% equity in the home without having to refinance the mortgage. Keep in mind that lenders won’t consider removing PMI until after about a two-year “seasoning period,” according to Keith Gumbinger, vice president of HSH.com, a mortgage information resource, “They may still deny the your request,” he Notes.
Track the appreciation of your property
Another way is to monitor the appreciation of your property. If the appraised value of your home increases, your equity in the home will increase. If this increase puts you above the 20% equity threshold, you can ask your lender to end PMI.
Don’t go alone
Couples can benefit from a dual-income mortgage loan to not only avoid higher interest rates, but also reduce any required PMI payments. “Something new we’ve seen recently is that PMI is lower with two incomes on the loan versus a single borrower,” Gumbinger says.
Consider an FHA loan
One way to avoid private mortgage insurance altogether is to get an FHA loan through the Federal Housing Administration. Private mortgage insurance does not extend to loans made by the FHA, because PMI only covers conventional mortgage lenders. However, it’s worth noting that FHA loans come with their own additional costs. FHA borrowers must pay for FHA mortgage insurance, but it tends to be less expensive than PMI costs.
Know the PMI increases
What most first-time buyers don’t consider is that PMI rates are applied in increments. So don’t assume that investing more money will reduce your PMI. It may make more sense to hold onto those additional funds for closing costs or an emergency fund. Here’s a handy calculator to decide whether or not to increase your down payment.
Ultimately, uncovering the hidden costs of PMI will help you plan for its timely demise.
(An earlier version of this story incorrectly listed Keith Gumbinger’s name.)