Is Private Mortgage Insurance (PMI) necessary? Will it help me buy a house? Is there a way around it? Those are the questions.
Actually, they probably constitute only the tip of the mortgage iceberg if you’re buying your first home. But squaring away the PMI query is an important effort that will help you zero in on the right loan for you and better understand your monthly commitment as a homeowner. Let’s tackle those questions.
So, what is PMI anyway?
Call it an insurance policy that protects your lender against the possibility that you could default on your loan. “One of the risk measures that lenders use in underwriting a mortgage is the mortgage's loan-to-value (LTV) ratio,” said Investopedia. “This is a simple calculation made by dividing the amount of the loan by the value of the home. The higher the LTV ratio, the higher the risk profile of the mortgage. Most mortgages with an LTV ratio greater than 80% require that private mortgage insurance (PMI) be paid by the borrower. That's because a borrower who owns less than 20% of the property's value is considered to be more likely to default on a loan.”
Why do I need it?
Coming up with 20% for a down payment obviously isn’t easy. “Many first-time homebuyers don't have that kind of money sitting around,” Randall Yates, founder and president of The Lenders Network, told us. So, PMI can spell the difference between being able to buy a home, and not—even if it costs you a couple hundred dollars a month.
How much will it cost me?
You can expect to pay between $30–70 for every $100,000 that you borrowed to purchase your home every month. Unison’s estimated monthly payments based on the example of a “30-year loan for $250,000 with an interest rate of 4 percent” breaks down as:
• Principal and interest: $1,194
• Property taxes: $100
• Homeowners insurance: $80
• PMI: $125
Do I have to pay PMI no matter what?
Not necessarily. “There are a couple alternatives that may work for some buyers,” said Yates. “If you're a veteran, you're in luck because VA loans are the only type of home loan that doesn't require PMI. A piggy-back mortgage or 80/10/10 is another option some buyers use if they do not have the full 20% down payment. The borrower puts 10% down and gets a second loan for the other half of the down payment. In this scenario, you would have two loans to repay, but you avoid paying PMI. If you're in a rural area, you could qualify for a USDA loan. USDA loans are a type of government-backed mortgage that does not require a down payment and has a very low PMI rate of just 0.35% of the loan amount.”
Can I ever get rid of PMI?
You can, but it’s not easy. “To remove PMI, or private mortgage insurance, you must have at least 20 percent equity in the home. You may ask the lender to cancel PMI when you have paid down the mortgage balance to 80 percent of the home’s original appraised value,” said Bankrate. “When the balance drops to 78 percent, the mortgage servicer is required to eliminate PMI. Although you can cancel private mortgage insurance, you cannot cancel Federal Housing Administration insurance. You can get rid of FHA insurance by refinancing into a non-FHA-insured loan.”
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