The homebuying process is a complicated set of steps that must take place before you assume ownership of a house. Most of these steps occur behind the scenes between real estate agents and attorneys.
However, there are some steps that include heavy involvement from a buyer, and with this involvement comes a lot of terminology that may not be familiar.
Even though a real estate agent takes care of all of the paperwork and ensures a smooth transaction, it is important that the buyer understands the general process.
A significant part of this process is the financing. Financing involves how the buyer plans to pay for the home, which includes payment type (cash or loan), down payment, and PMI. A small portion of buyers do purchase in all cash, but most must use a loan.
There are certain conditions that lenders require when taking out a loan. One of these conditions is a down payment, and when buyers do not have a certain percentage of money to put down, a subsequent condition is PMI.
PMI stands for private mortgage insurance. We will dig more into this topic in the remainder of the article.
What Is PMI in Mortgages?
PMI or private mortgage insurance is a type of insurance that a buyer might be required to pay if they put less than 20% down on a home purchase. PMI in mortgages is organized by the lender that you are working with, but it is offered by private insurance companies.
You might be wondering who this insurance benefits, and the answer might surprise you. The insurance is not for your benefit; it actually serves as protection for the lender. Should you stop paying your mortgage, the lender is protected by private mortgage insurance.
Let’s discuss the protection that PMI provides in a little more detail. It is important to understand and remember that PMI does not protect you—the consumer and the homebuyer. It only protects the lender.
This means that if you stop paying your mortgage, the lender is safeguarded from your inability to pay, but again, you are not protected from any consequences. If you do not pay your mortgage each month on time, you are running the risk of foreclosure and losing your home forever.
PMI can be viewed positively or negatively, depending on your mindset. First, let’s look at the positive aspect to PMI.
PMI makes buying a house possible for those buyers who do not have 20% to put down. The age-old belief is that you cannot purchase a home without supplying a 20% down payment at closing. This is absolutely not the case, and PMI is to thank.
As mentioned, PMI provides security for lenders as they are taking a bigger risk on buyers who do not put down this amount. These buyers are a gamble to lenders because they will have a larger principal balance and larger payments, therefore more of a chance of defaulting. Lenders take that chance on buyers who otherwise wouldn’t be able to buy a home thanks to the security that PMI offers.
When looking at PMI in a negative light, it’s plain and simple. PMI is an additional cost to buyers in an already expensive venture. This added expense can seem daunting. It may even cause buyers to lower their target price range as they may not be able to afford as much.
It’s easy to only look at the negative piece to this because it is money coming out of your pocket that could have been put to use in other ways. However, try to reel those thoughts back in because PMI might just be the main reason you have a home to call your own.
How Does PMI Work?
Although it is not required that a buyer put 20% down on a home, it will save you money in the long-term. With some mortgages, the terms will allow for as low as a 3.5% down payment. This is what makes homeowning feasible for so many individuals and families.
However, with a down payment less than 20%, it is likely that PMI will be a part of your financing and contract.
In short, here is a brief explanation of how PMI fits into the homebuying process. A homebuyer visits a lender and requests a preapproval for a home. That lender runs the buyers report and comes up with an estimated price that the consumer can afford. The homebuyer tours a few homes and finds one to put an offer in on, which includes information such as the down payment and loan type.
The seller accepts the offer, and the buyer progresses to the next set of steps, including home inspection and appraisal. Once the appraisal comes back (and depending on results), financing can continue to move forward.
At this point, the buyer will be waiting for the financing to go through and will have official figures for purchase price, loan amount, interest rate, PMI expense, and closing costs. The final PMI cost doesn’t come in to play until the end of both the homebuying and financing process.
How Much Is PMI a Month on a Mortgage?
The amount that a buyer will have to pay for PMI will vary. There are multiple factors that go into the dollar amount, typically paid monthly, for PMI. These considerations include down payment amount, credit score, and loan terms. The lender uses these pieces of information to gauge the level of risk that you pose.
The larger the down payment amount and credit score, the greater the likelihood that your PMI costs will be on the lower side, and the opposite is true. Typically, the PMI fee will fall between 0.3% and 1.5% of the annual loan balance.
Using a PMI calculator is a great way to get a grasp on what you might be paying monthly for PMI as well as other related estimated costs expected for the duration of the loan.
What Is PMI Insurance, and Is It the Same as PMI?
PMI is the abbreviation of private mortgage insurance. Therefore, PMI insurance and PMI are the same thing. It is a complex part of the financing involved in buying a home.
There are many components to obtaining a mortgage and affording a home. Private mortgage insurance is only one small piece of the larger financial picture. Taking the time to understand when PMI is assessed and the expense that it adds to your monthly mortgage payment is essential. You can expect that PMI will cost you anywhere between $80 to $250 a month for an average priced home, given that the average sits around $260,000.
How Is PMI for a Mortgage?
It is a good idea to speak with a professional to learn your options when it comes to PMI for a mortgage. There are numerous options for mortgages through both banks and mortgage brokers.
You should consider speaking with a few mortgage specialists and acquire all of the various options that each are able to offer you. Mortgage brokers have access to a wider selection of loan types through multiple lenders. Banks only have their selection of products to offer consumers.
You may be thinking, “Why does anyone use a bank over a broker?” It is possible that the bank’s opportunity for your specific situation is more attractive than that of the mortgage broker. However, you won’t know who has the best option for you unless you take the time to shop around. Those options are all going to be dependent upon your situation, the market, and the economy.
When Do You Have to Pay PMI on a Mortgage?
PMI is paid monthly (most often) with the loan for the home. There are some cases where PMI is paid upfront and other instances where a small sum is paid at closing and the rest is paid monthly.
PMI will automatically fall off when your loan’s principal balance reaches 78% loan-to-value (LTV). This figure is based on the lower of either the purchase price or the date of purchase appraisal value.
If you are diligent, you can contact your lender when your home reaches 80% LTV and have it cancelled immediately. If you do not do this, then that is when the automatic termination of PMI occurs at 78%.
It is important to note that a lender will not automatically cancel at 80% LTV, but the homeowner can request the termination at this point. It will only automatically terminate once it has reached 78%, given that the loan is current.
If the loan is in default, then PMI will not automatically cease. The loan will have to be brought up-to-date on payments. Once this has taken place, PMI will be stopped on the first day of the following month.
There are some loans where PMI is not released at 80% LTV and continues for the life of the loan. When you run into this situation and plan to remain at that property for at least a few years, then it is advised you consider refinancing to drop the PMI. There are conditions to refinancing out of having to pay PMI, so consider researching the options available to you or speaking with a mortgage professional.
How to Avoid PMI on Mortgages
There are a couple of ways to avoid paying PMI when purchasing a house.
A piggyback mortgage is a second loan taken out to cover the outstanding amount of the down payment needed to reach the 20%.
Typically, a buyer will need to have a 10% down payment to qualify for this option. Since this loan helps the buyer achieve a 20% down payment, they fulfill the requirements, and no PMI is administered.
Lender-Paid Mortgage Insurance
Lender-paid mortgage insurance (LPMI) is where the lender takes on the insurance premium cost and, in return, charges the buyer a higher interest rate. Unlike traditional PMI, this option does not disappear when the owner reaches a certain percentage paid. LPMI stays with the owner for the duration of the loan. This option is offered on a lender-to-lender basis.
No PMI Loan Program
Lenders are able to create their own programs, and on occasion, a program may not require PMI regardless of the size of the down payment. This option is highly dependent on the lender’s offerings.
It is a good idea to research various lenders to see if they offer this type of program and what the conditions might be to obtain this loan type. Some of these requisites might include excellent credit, income maximums, a specific down payment percentage, loan minimums/maximums, and homeownership classes.
There is only one true way to avoid paying PMI and having zero stipulations to the agreement with the bank/broker—putting 20% down on the home.
Private mortgage insurance is protection for the lender as they are liable for that loan. Therefore, this insurance will almost always be an added expense for any buyer that is unable to put 20% down on a home.
There is one exception to this, but it is only available to a select market, and that is through a VA loan. VA loans are a type of financing offered to active military and veteran status buyers. There are a few stipulations to this type of loan, but the most attractive piece is that a down payment is not required, and PMI is not a part of the financing.
Remember, PMI is avoidable, but not easily. Having to pay private mortgage insurance is not going to break the bank, but the cost should be a significant factor when determining your price range as it’s an added cost to your monthly payment.
Keep in mind that putting even five dollars a month toward your principal balance will have a significant effect on paying down your loan. That means you’ll be making strides to reach that 80% LTV even faster too.
In the long run, even with a monthly PMI cost, you will save money by purchasing a home versus renting. It may not be ideal to have this added cost, but a home is an investment and must be viewed as such.
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