Last article we continued our discussion on mortgages when we went over discount points. When all the posts in the series are complete, you should have an understanding of mortgage types, structure, rates, points, fees, mortgage insurance, and refinancing. This week we are going over Private Mortgage Insurance (PMI).
- 1 – Common Types of Mortgages
- 2 – Mortgage Structure, What is PITI?
- 3 – Interest Rate vs APR
- 4 – Origination Fees and Closing Costs
- 5 – Discount Points
- 6 – Private Mortgage Insurance (PMI)
What is PMI?
Any time you make less than a 20% down payment on a home, you have to purchase Private Mortgage Insurance (PMI). The purpose of PMI is to protect the lender’s investment in the home. This helps home buyers purchase a home sooner. The reason the lender may require PMI is because the less equity you have in the home, the higher of a risk the bank is taking by lending you the money.
The cost of PMI can range from .25% to 2% the value of the home. The most common amount you’ll see is 1%. This can be affected by the size of the loan, the value of the home, your credit score, and other financial risk factors. The reason you may take this route is because when markets are low and buying is best, it allows you to jump in to gain on appreciation of a home. If you are a renter, you can turn your rent check into an equity building tool for an asset rather than just a monthly expense.
4 Types of PMI
This is the most common type of PMI. Typically, if the specific type of insurance isn’t specified, this is the type it’s talking about. BPMI is an additional monthly fee that’s added to your mortgage payment. You will pay BPMI every month until you reach 22% equity in your home (based on original purchase price). At this point the lender must automatically cancel the BPMI. On average, it takes borrowers 11 years to pay off their BPMI.
For the typical borrower, it takes 11 years to pay off PMI.
You can also request to have BPMI canceled when you reach 20% equity in your home. However, you must have no additional liens on your property, have an acceptable payment history, and sometimes even get a current appraisal. While not required, some lenders will actually allow borrowers to use appreciation as equity gain to stop PMI payment. So if you buy a $100,000 home with $10,000 down, and you make payments and eventually the house appraises for $150,000, you would have $60,000 in equity plus payments giving you more than 20%. Even though you haven’t made the additional 10% in payments, they could consider the appreciation as equity gained.
A less common form of PMI, LPMI is paid by the lender. However, you will end up paying for it in the long run through a higher interest rate. With LPMI, you can’t cancel it and it’s non-refundable even if you refinance. Since LPMI is built into the loan, there’s no way to stop paying it until you refinance.
With SPMI you will pay the mortgage insurance up-front either at closing or by financing it into the mortgage. The benefit of this is that you can qualify to borrow more and you don’t have to refinance to get out of the PMI. The downside is that if you sell the home or refinance too soon the payment is non-refundable. So where you would stop paying PMI with BPMI, with SPMI you just lose what you put into it. Either way, talking to an experienced loan officer about your goals and options is always the best route.
This is the least common type of PMI. It’s a hybrid of BPMI and SPMI. You pay a portion of the insurance up-front and then the rest monthly. This lets you lower your monthly PMI payment, but also keeps you from having to pay as much up-front. If your lump sum is wrapped into the loan, this also helps keep you from financing the insurance. Keeping you from paying interest on a fee you are already paying extra for.
There are two types of loans where PMI is either replaced or dropped. With a VA loan, you would pay a VA funding fee up-front. Veterans that have a certain disability rating may be eligible to have this fee waived. The best thing to do is contact your local Veterans Affairs office for more information and requirements. The other is the FHA loan. For most people, this will actually be more expensive than PMI. FHA requires an up-front premium that does nothing to affect your monthly premiums. You can finance this up-front premium, but keep in mind that you will be paying interest on it and that will make it more expensive over time.
FHA loans are more expensive overall. There is a reason people pick it though. FHA has less stringent restrictions on credit scores than conventional. Additionally, FHA loans allow the seller to contribute up to 6% to the buyers closing costs versus the typical 3% allowed with a conventional loan.
There’s no doubt that PMI is an expensive addition to getting a loan. While it does allow people to own a home who may not traditionally be able to afford one, it’s still a cost. It’s important to reach out to a financial advisor and talk to an experienced loan officer to see what your options are.