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Say you want to buy a house but haven’t saved up the 20% down payment required for most home purchases. What can you do?
You can still buy your dream home, but more likely than not, your lender will require that you get Private Mortgage Insurance, or PMI.
This allows some buyers to qualify for a loan that they otherwise wouldn’t be able to, but may increase the cost of your loan. PMI also is required if a borrower refinances the mortgage with less than 20% equity. PMI is designed to protect your lender, not you, AKA the borrower, in case you default on your loan.
PMI can help borrowers who can only afford to put down between 5% to 19.99% of a home’s cost. PMI typically ranges between .50% to 1% (though sometimes costs can be higher or lower) of your loan balance per year. This percentage is based on the size of the down payment and mortgage, the loan term, and your credit score. The higher risk you have in each of these categories, the higher rate you’ll pay. Because PMI is a percentage of the loan amount, the more you have to borrow the more PMI you have to pay.
Borrowers will pay PMI until they’ve accumulated enough equity that the lender doesn’t see them as high-risk. Once the loan-to-value ratio drops below 80%, borrowers can submit a request that these monthly mortgage insurance payments be eliminated. Once the loan-to-value ratio drops to 78% the lender is legally required by the Homeowners Protection Act to cancel PMI.
There are many different ways you can pay for PMI and some lenders will offer multiple options. You should be aware of what payment options are available to you before you agree to a mortgage. Here are a couple common options:
- Monthly Premium - the most common way to pay for PMI, the premium is added to your mortgage payment
- One Time Upfront - paid at closing, a Single Premium PMI, this option can save you money in the long run
- Upfront and Monthly - a combination of the previous two payment methods where you pay an upfront premium and a premium is added to your monthly mortgage payment
There are three different types of PMI.
1. Single Premium PMI
Eliminate the need for a monthly payment by paying the mortgage insurance premium in a single lump sum either at closing or financed into the mortgage. Though the upfront cost may deter borrowers, this option can save you a lot of money in the long run.
2. Lender-Paid PMI (LPMI)
In this situation, the lender pays the PMI on your behalf. While this may make your monthly mortgage payment lower, rates are usually higher for LMPI meaning you’ll end up paying more interest over the life of the loan. LPMI is also a permanent part of the loan and cannot be canceled.
3. Borrower-Paid PMI (BPMI)
You pay a monthly premium until your PMI is terminated when it reaches a loan-to-value balance of 78% or canceled at your request. Lenders are required to provide a written statement to the buyer at closing, letting them know how long it will take for them to pay 20% of the mortgage principal. However, this is an estimate based on your amortization schedule and not on your actual payments. As a result of this, it’s important to keep track of your mortgage payments and equity buildup because you may reach the 78% threshold sooner than scheduled. However, your lender does not have to terminate your PMI until the originally scheduled date which could mean you’re paying PMI for months or even years unnecessarily. For this reason, many people avoid BPMI.
Want to buy a house but don’t have the 20% down needed and don’t want to get PMI? There are other options. Check out our blog on down payment assistance for more information.