The Cost Of Mortgage Insurance (PMI) And How To Save On It

When purchasing a home, many buyers face the challenge of putting down a substantial down payment. However, if a buyer can’t afford a large enough down payment (typically 20% of the home’s price), they may be required to pay for Private Cost Of Mortgage Insurance (PMI). While PMI serves as a safety net for lenders, it comes at a significant cost to the borrower. Understanding the cost of PMI and how to save on it is crucial for homeowners looking to minimize their monthly mortgage payments.

What is PMI?

Private Mortgage Insurance (PMI) is typically required for conventional loans when the borrower makes a down payment of less than 20% of the home’s purchase price. PMI protects the lender in case the borrower defaults on the loan. While PMI does not benefit the borrower directly, it allows homebuyers to purchase a home with a smaller down payment, thus making homeownership more accessible.

PMI is not a one-time cost but rather a monthly or one-time premium that the borrower must pay until they have enough equity in the home (usually 20%) to cancel the insurance.

How Much Does PMI Cost?

The cost of PMI varies depending on several factors, including the size of the down payment, the loan amount, the lender, and the borrower’s credit score. On average, PMI premiums range from 0.3% to 1.5% of the original loan amount per year. For example, if you take out a $200,000 loan and your PMI rate is 1%, you could pay $2,000 annually or around $167 per month in PMI.

The actual rate can depend on:

• Loan-to-Value (LTV) Ratio: The lower your down payment, the higher the PMI rate. A higher LTV ratio (meaning you’re borrowing more of the home’s value) will lead to a higher premium.
• Credit Score: Borrowers with higher credit scores tend to have lower PMI premiums since they’re seen as less risky to lenders.
• Loan Type: Some loan programs may have different PMI requirements. For example, government-backed FHA loans have different insurance costs compared to conventional loans.

Types of PMI

There are a few different ways that PMI premiums are structured:

1. Monthly PMI: The most common type, where borrowers pay a monthly premium along with their regular mortgage payment.
2. One-Time PMI: A lump-sum premium is paid at closing. While this can be more expensive upfront, it eliminates ongoing monthly payments.
3. Split-Premium PMI: This is a combination of both, where part of the premium is paid upfront, and the rest is paid monthly.

How to Save on PMI

While PMI is often an unavoidable cost for buyers with less than 20% down, there are several strategies to reduce the overall cost of PMI or eliminate it faster.

1. Increase Your Down Payment The most straightforward way to avoid PMI is by putting down at least 20% on your home purchase. While this requires significant savings, it can save you thousands of dollars over the life of the loan by avoiding the need for PMI altogether. In addition, a larger down payment may also result in a lower interest rate, which can further reduce your monthly payment.
2. Shop Around for PMI Rates Not all PMI providers offer the same rates. It’s important to shop around and compare premiums from different lenders and insurers. Some lenders might offer PMI at a lower rate than others, so getting quotes from multiple providers can help you find the best deal.
3. Opt for Lender-Paid Mortgage Insurance (LPMI) Lender-paid mortgage insurance (LPMI) is an alternative to borrower-paid PMI. With LPMI, the lender covers the cost of PMI, but in return, the borrower typically pays a higher interest rate on the loan. Depending on your financial situation, this could result in a lower overall cost if you plan to stay in the home for a long period.
4. Consider a “Piggyback” Loan A piggyback loan, also known as an 80-10-10 loan, involves taking out a second mortgage to cover part of the down payment. For example, you could get a first mortgage for 80% of the home’s price, a second mortgage for 10%, and you would cover the remaining 10% as a down payment. This strategy allows you to avoid PMI altogether, but it requires qualifying for both loans and could increase your monthly payments due to the second mortgage.
5. Request PMI Cancellation If you’ve been paying PMI for a while and your home’s value has appreciated or you’ve paid down a significant portion of your mortgage, you may be able to cancel PMI early. Under federal law, lenders are required to automatically cancel PMI once your loan balance reaches 78% of the home’s original value. However, you can request cancellation when your loan balance reaches 80% if you have a good payment history and meet certain other criteria.
6. Refinance Your Mortgage If your home has gained value, refinancing could help you eliminate PMI. When you refinance, you may be able to reduce your loan-to-value ratio and reach the 80% threshold, allowing you to cancel PMI. However, refinancing comes with its own costs, so it’s essential to evaluate whether this option makes financial sense in the long run.

FAQs About PMI

1. Can PMI be canceled?
Yes, PMI can be canceled once your loan balance reaches 80% of the original home value. In some cases, you may request cancellation before that, depending on your loan terms.

2. Is PMI tax-deductible?
PMI was tax-deductible for some homeowners in the past, but as of 2021, it is no longer deductible under current IRS rules. Be sure to check the latest tax laws for potential changes.

3. How long do you need to pay PMI?
PMI is typically required until the loan balance reaches 78% of the home’s original value, but you can request cancellation at 80%. However, the total duration will depend on your payments and home value.

4. Can I avoid PMI with less than 20% down?
Yes, some strategies like piggyback loans or lender-paid mortgage insurance (LPMI) can help you avoid PMI with a smaller down payment.

5. Does PMI go away automatically?
Yes, once you’ve reached 78% of the original home value, PMI should automatically be canceled by the lender.

Also Read : What Are The Most Common Mortgage Terms You Should Know?

Conclusion

While PMI can add a significant cost to your monthly mortgage payment, it serves as a stepping stone to homeownership for those who can’t afford a 20% down payment. By understanding how PMI works and exploring ways to reduce or eliminate it, you can save money and move closer to paying off your home faster. Whether it’s opting for a larger down payment, shopping for the best rates, or exploring alternative loan structures, there are multiple strategies to reduce your overall cost of PMI.