You’ve been saving for the perfect house. You’ve run the numbers, been pre-approved and you’re all set to buy. You calculate what percentage down payment you have but realize it’s only 18 percent, not the 20 percent you had originally forecast. So what now?
PMI. Private mortgage insurance. Not exactly the words any buyer wants to hear, but often times necessary nonetheless. But exactly what is PMI? How does it work, what does it cover and what does it cost?
What is PMI?
Private mortgage insurance is insurance that lenders require from homeowners who obtain loans for greater than 80 percent of the home’s market value. If you have less than a 20 percent down payment, you will be required to purchase PMI. In the past years of easy credit, lenders would sometimes piggy-back a second mortgage or lien onto the existing first mortgage to avoid PMI, but that is not the case anymore.
How does PMI work?
PMI is designed to protect the lender in case of a default on higher risk loans, such as loans where they are funding more than 80 percent of the value of the home. With PMI, the buyer is paying for the insurance on a monthly basis on top of the principal and interest on the loan, taxes and homeowner’s insurance. The upside to PMI is that it acts as a “foot in the door” for buyers by allowing them to purchase a home with a much smaller down payment than the 20 percent generally required.
What does it cost?
The average cost of private mortgage insurance premiums vary, but generally they are between 0.5-1 percent of the total loan amount depending on the purchase price and the down payment used. These premiums are not always tax deductible and are not dependent on the risk involved. Having good or bad credit gets you the same PMI premiums because it is calculated on the down payment and purchase price only, not your credit score.
When do I stop paying PMI?
PMI is terminated when the equity in the property is valued at 20 percent of the purchase price. There are various ways to meet this criteria.
• Appraisal: if the property value goes up, you can have an appraisal done to see if the equity in your home has increased. If the loan-to-value ratio falls below the 80 percent required by your lender, you can eliminate the PMI.
• Mortgage Payments: once your payments help you achieve 20 percent equity, PMI will be cancelled. Making small additional payments directly to the principal can make a big difference over time.
• Remodel: making improvements and having the home reappraised can result in your loan-to-value ratio dropping below the 80 percent threshold. This is a good option if you are making improvements anyway and want to try to lower your monthly payments by eliminating the PMI.
If you additional questions about PMI or mortgages, please visit out website at www.heartrealtors.com and speak with one of our preferred lenders. You can also contact me directly at [email protected] or 310-259-7419.