You might be in for a shock when you make your first mortgage payment. Private mortgage insurance, or PMI, is an optional extra that some lenders require borrowers to pay on top of the principal and interest payments.
Certain types of conventional loans are ineligible for private mortgage insurance. You can choose to pay the annual fee in monthly installments or all at once, but you won’t have to do so for the duration of your mortgage. Understand what private mortgage insurance (PMI) is, how it operates, and what steps need to be taken to fulfill this financing requirement if you wind up owing PMI.
If you cease making payments that are in accordance with the terms of your loan, you may be in default, and your lender may seek financial compensation through private mortgage insurance. Borrowers who are considered high-risk by lenders are often required to purchase private mortgage insurance. This plan might run as long as it takes for the lender to feel comfortable with the borrower’s equity level in the loan. The borrower will no longer pose a greater risk to the lender after that point.
When a borrower puts down less than 20% on a home using a traditional loan, the lender will typically require them to pay for private mortgage insurance. Lenders won’t give money to customers who can’t come up with a sizable down payment unless they have private mortgage insurance.
You can avoid having to pay private mortgage insurance in addition to making a larger down payment on a home. Even if the loan amount is equal to or greater than the home’s worth (known as “100% financing”), private mortgage insurance will typically not be required for a non-conventional loan. In this case, you won’t be able to make a down payment. Lenders don’t require further protection against mortgage defaults on these non-conventional loans because the U.S. government often guarantees them.
The premium for private mortgage insurance typically rises alongside the price of the home. Private mortgage insurance typically ranges in price from 1%. Even though it doesn’t seem like much, that’s a sizable chunk of your mortgage payment. For a home costing $200,000, the annual cost would be between $1,000 and $2,000 if no down payment was made. This could increase your monthly payments by $150.
If you pay the private mortgage insurance premiums at the rate of $150 per month for the next five years, you will have spent a total of $9,000. Every month, you’re just flushing money down the toilet because it doesn’t go toward paying off the loan. Think about the fact that, depending on the size of your down payment and the length of your loan, you may be making those payments for more than five years.
Even if you’ve already closed on a property, you can still cancel your PMI with a little work. Your mortgage insurance premiums may be canceled by your lender if you’ve paid down your principal by at least 20% of the home’s value. You can start saving that money sooner if you make larger principle payments.
With a loan-to-value ratio of 80% or less at closing, private mortgage insurance is not required. This occurs when the down payment is at least 20% or when the amount borrowed is at least 20% lower than the purchase price.
If you won’t be able to come up with a 20% down payment, but your mortgage lender allows it, you can seek a second mortgage (called a piggyback mortgage) to offset the difference. Both mortgage payments are still your responsibility; however, the second one will be substantially cheaper thanks to not having to pay private mortgage insurance.
The mortgage is a legally binding agreement. While it’s possible you won’t be allowed to alter certain boilerplate clauses, just about everything else is open to discussion. There are financial institutions that will shoulder the cost of PMI on a borrower’s behalf. The borrower agrees to pay a higher interest rate throughout the life of the loan in exchange for the lender’s promise that, once the loan-to-value ratio reaches 80%, the borrower will no longer be responsible for paying private mortgage insurance.