According to the National Association of Realtors, in 2014 the average home buyer financed 90% of the sales price when buying a home.
In today’s economy, U.S. home buyers are happy to have options available to them for putting less than 20% down.
By putting less than 20% down however, there’s an extra cost that comes in the form of insurance known as PMI (Private Mortgage Insurance). Mortgage insurance is a monthly payment added to your mortgage payment and, for conventional loans, it’s required until your home’s equity reaches 20% in equity.
WHAT IS PMI AND WHY DO I HAVE TO PAY IT?
Private Mortgage Insurance (PMI) is insurance meant to protect the lender in case of default. For conventional loans, PMI is required on all loans when a down payment is less than 20%.
Lenders know that borrowers are far less likely to default on their loan when they have a significant financial interest in the property, such as a 20% down payment.
The lender is assuming the risk when accepting a lower down payment. To offset this risk, lenders require that borrowers purchase private mortgage insurance.
PMI is referred to as “private” mortgage insurance because it is only offered to private companies, not government agencies or public mortgage companies. Private Mortgage Insurance applies to conventional loans only.
The Federal Housing Administration (FHA) has their own type of mortgage insurance known as a Mortgage Insurance Premium (MIP). FHA has their own insurance but it is run differently and managed internally.
A defining difference between PMI and the mortgage insurance that is attached to FHA loans is that the latter never expires. A borrower will continue to pay mortgage insurance on an FHA loan even after the loan to value ratio has dropped below 80%.
HOW MUCH DOES PMI COST?
PMI costs vary from .3% to 1.15% of the loan balance, depending on various factors such as credit score, down payment and loan term. The greater the risk factors, the higher the PMI rate paid.
The annual cost is usually divided into 12 monthly installments and then added to your monthly mortgage payment.
For someone with a 740 credit score obtaining a 30-year fixed mortgage, a typical charge for every $100,000 borrowed will result in a monthly charge of approximately $30 – $60. For example, someone borrowing $250,000 with a 5% down payment can estimate private mortgage insurance costs of roughly $90 – $130 per month.
PMI fees and monthly premiums can change frequently. Although most PMI rates will be similar from one provider to the next, they can vary from state to state and are subject to market conditions.
Check with your local mortgage lender for specific information regarding PMI expenses on your mortgage.
WHEN CAN PRIVATE MORTGAGE INSURANCE BE CANCELED?
Generally, PMI can be canceled once your original principle balance is less than 80% of the original appraised value or contracted sales price, or of the current market value. There are however restrictions that may apply, such as a history of timely payments, a minimum number of payments made, and the absence of a second mortgage.
It is required that mortgage lenders inform borrowers of the length of time it will take to reach a certain loan-to-value point, as well as update you annually of any cancellation options.
According to the Homeowners Protection Act of 1998, lenders are required by law to automatically terminate PMI once the homeowner reaches 78% loan-to-value (LTV), or gains 22% equity in their home. This equity position is based on the original property value or lesser of the purchase price/appraised value.
You must be current on your loan when you reach the 78% LTV to get your PMI removed. If you’re not current, the good news is that your PMI will be automatically terminated on the first day of the first month following the date that you become current on your mortgage.
The law also states that homeowners are permitted to request the termination of PMI once they gain 20% equity in their home, or 80% of the original value. Bear in the mind that the lender will not contact you. You will need to contact your lender and that the PMI be removed. Again, you must have a good payment history, be current on your loan and submit a written cancellation request.
HOW CAN PMI BE AVOIDED?
There are a number of ways to avoid paying private mortgage insurance.
- The easiest way to get rid of, or not have to pay PMI to begin with, is to put down 20% percent or more.
- Many lenders offer a higher interest rate in exchange for avoiding PMI. This is commonly referred to as LPMI or Lender Paid Mortgage Insurance. The increase to your rate will typically range from .25% to .75%. Your mortgage lender can compare the two options, as well as discuss the pros and cons of both with you.
- Although less common nowadays, you can take out a “piggyback” loan. For example, some lenders will offer you a 75/15/10. This loan consists of a 10% down payment, a 75% first mortgage and a 15% second mortgage.
If you currently have a mortgage loan with PMI, you may be able to refinance out of it. As long as your appraisal reflects an equity position of 20%, or an LTV of 80%, you can get rid of PMI.
Although it’s not always best to refinance just to get out of PMI, if you can get a lower rate in the process, it could be a win-win.
You don’t need 20% down to buy a home; and PMI is not a terrible thing. Find out about how PMI works with your loan and when you can cancel prior to getting your new mortgage loan.