The home buying process can be incredibly confusing, especially when your lender starts throwing around words like Private Mortgage Insurance, or PMI for short. You're likely wondering what PMI actually is and more importantly if this additional cost is necessary.
Let's look at what Private Mortgage Insurance is, and then we'll go over some tips that might allow you to avoid this additional cost completely.What is Private Mortgage Insurance (PMI)?
PMI or Private Mortgage Insurance protects the lender in the event that you default on your loan, and comes with a monthly premium cost that is passed on to you as part of your mortgage. Private Mortgage Insurance fees can vary significantly and generally range from 0.3% to 1.5% of the original loan amount per year. Factors that affect your Private Mortgage Insurance rate include the amount of your down payment as well as your credit score. The cost of Private Mortgage Insurance can add up rather quickly, adding a considerable amount to your monthly mortgage payment, so make sure to discuss your rate as well as what PMI will add to your monthly mortgage payment directly with your lender.
It is important to understand that Private Mortgage insurance is NOT the same as Homeowners Insurance and does not protect you or your home as Home Insurance does. Please consult a Local Insurance Agent that will be able to ensure that you are adequately covered by a Homeowners Insurance Policy in the event that you suffer a claim.How do I pay for Private Mortgage Insurance?
Traditionally the cost of Private Mortgage Insurance is passed on to the buyer as a part of their monthly mortgage payment. Consider this similar to paying your auto insurance on a monthly basis. This stretches the annual premium across 12 months allowing the buyer to pay it in more manageable chunks. This will of course result in a higher monthly mortgage payment, which is why it is always recommended to find out from your lender what the PMI cost will be so that it doesn't surprise you at closing!
Some banks have begun requiring payment of the Private Mortgage Insurance in an upfront payment at closing. In addition to adding a significant amount to the buyer's closing costs, these prepaid PMI Premiums are generally nonrefundable in the event that Private Mortgage Insurance is no longer required.
Home buyers with higher credit scores may qualify for Lender-Paid Mortgage Insurance in exchange for a higher interest rate. While this means that your lender will be responsible for the cost of the Mortgage Insurance, it will result in a higher interest rate for the life of the loan which can add up to big bucks. It does of course depend on your individual needs; a home buyer that is focused on lower monthly payments for instance (at the expense of a higher overall cost) may benefit from this option. If considering this route, be sure to compare your cost over the life of the loan as calculated with the higher interest rate against your cost with traditional Private Mortgage Insurance (and keep in mind that you often do not need to pay PMI for the life of the loan).What are the benefits of Private Mortgage Insurance?
As Private Mortgage Insurance allows you to purchase a home with less down, it can help you qualify for a loan that you might not otherwise be able to get. PMI would allow you to purchase a home sooner for instance, rather than waiting until you've saved enough money to put 20% down at closing.Do I need Private Mortgage Insurance?
Not necessarily. It is possible to avoid the additional cost of PMI by putting 20% down at closing, which can represent a significant savings. Many home buyers conscious of the impact PMI can have on their monthly payments attempt to stay within a budget where putting 20% down is possible in order to avoid this additional cost.
If you do have PMI included in your mortgage, it is important to keep in mind that once the equity you have in your home reaches 20%, you are able to request that your lender cancel the Private Mortgage Insurance going forward.
There are a couple of ways to go about this:
Once your mortgage payments have paid down 20% of the principle of the loan, you can ask your lender to drop the private mortgage insurance.
Once your loan balance is below 78% of its original value your bank is required to drop PMI from your loan.
Once you have built 20% or more in equity in the home. In cases where you were able to get a deal on the home where you started with equity, or over time increased the value of the home through renovations and additions, you may be able to drop your PMI. This likely will require that you have an appraisal completed supporting this adjusted value of the property, but each lender may have different requirements. Review this option directly with your lender to determine the costs that would be incurred as well as the potential savings as the cost may outweigh the savings depending on your banks requirements.
We hope this answered your questions about Private Mortgage Insurance and most of all want to wish you the best of luck with your house hunt!
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