April 21st, 2016
If you are one of the many renters wanting to buy your first home, you may have come across the acronym PMI, which stands for private mortgage insurance. While PMI results in additional monthly or annual payments, it may be financially beneficial to consider a mortgage with a PMI plan. Consult with your real estate agent and reputable mortgage loan officer to determine whether PMI is appropriate for your financial situation.
If your down payment is less than 20% of your home's value, the lender may want you to purchase PMI to cover its losses in case you default on the payments. Typically, you will pay a PMI monthly along with each month’s mortgage payment. Your PMI can be canceled at your request, in writing, when you reach 20% equity in your home based on your original purchase price if your mortgage payments are current and you have a good payment history. By federal law your PMI payments will automatically stop when you acquire 22% equity in your home based on the original appraised value of the house as long as your mortgage payments are current.
You may have also heard of FHA loans. Federal Housing Administration loans can be great for low credit but can also be expensive. They have low down-payment requirements which can be in the form of a gift. PMI is different than FHA. Recent FHA-insured loans require payment of mortgage insurance premiums for the life of the loan. The mortgage insurance premiums can’t be canceled. Instead, you have to refinance the loan.
PMI is also different from homeowner’s insurance. Homeowner’s insurance protects the owner of the home, who also pays the insurance premiums. Private mortgage insurance, on the other hand, is paid by the homeowner monthly but protects the mortgage lender.
According to Bankrate.com, PMI usually costs between .5 and 1 percent of the total loan amount. This figure is the annual premium, which is divided into monthly payments. According to Allie Mae, average monthly costs tend to run between $50 and $80 per month. However, prices also vary based on down payment amounts and the type of mortgage. So talk with your loan professional if it’s required for you, and how much it will add to your monthly costs.
If your home increases dramatically in value, then it’s time to look into canceling your PMI. In general, on a 30 year fixed rate mortgage, it takes approximately 15 years to build up to 22% equity. This may seem a little astonishing, but it’s in the nature of an amortized loan. You pay mostly interest in the beginning and slowly chip away at the principal. This is why it’s great to pay even a few extra dollars a month towards the principal of the loan. So your next step would be to pay for an appraisal. If your equity is 20% or greater, request that your PMI be canceled in writing. (And put the money that went towards PMI directly to your loan. You will pay it down even faster, and you’ve already learned you can live without that extra money each month.)
If you’re applying for a VA loan, you should never be required to pay PMI. If it looks like it’s added in, double check with your loan officer that the loan is a VA specific loan or perhaps the fees are for something else.