HomeManaging Finances

Does it ever make sense to pay PMI (Private Mortgage Insurance)?

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When you want to buy a home, you will buy something that will most likely become one of the most important assets in your personal asset portfolio.

With so much of your net worth tied up in your home, it will be your duty to consider taking any steps you can to protect your asset and underlying investment.

For starters you’ll definitely want to buy a homeowners insurance policy to protect your home’s structure and contents from natural disasters (tornadoes, hurricanes, earthquakes, etc.) and fires / floods.

Homeowners insurance is designed to protect you and your investment.

young black woman holding keys for new home purchase

What you may not think of is that your lender also has an investment in your home. It sits in the form of the bond they hold against the title of the property.

If something were to happen to destroy the home and its value, your lender would theoretically have a mortgage on a piece of property that is worth significantly less than the money they are owed.

This is not a risk that lenders would like to take if you decide to walk away from the damaged property instead of repairing it.

Second, the lender always runs the risk of not making your mortgage payments despite your best intentions.

Lenders also do not really like to take that risk if they can not claim at least 20% equity in the property from negative. Yes, most lenders are risk averse.

For the protection of your lender, you may have the option to purchase private mortgage insurance or a PMI policy.

In fact, your lender may require you to purchase a PMI policy as a condition of mortgage approval.

In the eyes of a mortgage lender, this protects them from losing property value or making you default on your mortgage payments.

This is a topic worthy of further discussion.

Who buys PMI?

PMI is only available to customers under certain circumstances. Only borrowers with a conventional loan or non-government loan are eligible to purchase a PMI policy.

For what it’s worth, FHA and USDA (government-backed loans) are subject to other mortgage insurance requirements, while VA loans usually do not require any type of mortgage insurance.

Although requirements may differ slightly from one lender to the next, most conventional mortgage lenders backed by Fannie Mae or Freddie Mac require the buyer to secure a PMI policy with a down payment of less than 20%.

Should the value of the home increase enough or the principal amount of the loan decrease enough to give the home a value of more than 80% of the mortgage balance, the need to carry PMI can be dismissed.

Note: Some mortgages are written where the borrower will automatically drop the PMI requirement when the loan balance is scheduled to reach 78% LTV, based on the loan’s amortization schedule. Alternatively, lenders can contact their lender and request the removal of the PMI requirement when appropriate.

Although not recommended, you can buy PMI even if your home value falls below the 80% LTV (Loan to Value) threshold.

Since PMI can be quite expensive, it is not uncommon for homeowners to purchase a PMI policy unless they have to meet the lender requirements.

Related: What Are The Best Financing Options To Buy A Home?

Pay for PMI

If you do have to buy PMI, how much it will cost you depends on a few factors such as the home’s purchase price, the mortgage amount and the loan term, your repayment amount and your credit score.

There are two common ways you can pay the mortgage insurance premiums.

The first way would be to pay a single premium before or at closing along with your other closing costs.

You can do this in cash, or you may have the option to buy the policy and have the lender roll it into the final loan amount.

The second way would be to agree to a convenient monthly payment plan.

Should you choose to go with the monthly premium option, your lender will most likely take on the responsibility of making the payment on your behalf while collecting the annual cost from you with each monthly mortgage payment.

Most homebuyers choose to pay every month because it makes it easier to waive the policy should their home fall below the 80% LTV threshold.

Does it ever make sense to pay PMI?

If you set the lender requirements aside, let’s assume for a moment that you have the option to insure a PMI policy or not. When will it make sense for you to do so?

There are two good reasons why you might want to accept the extra costs associated with PMI.

1. To save your cash

In a robust real estate market where prices are trending higher, the need for PMI may be temporary.

In such cases, you may want to consider saving your cash assets by going with a lower down payment to buy a home.

Saving your cash could potentially open up the possibility of other investments or uses of the extra money.

Here is a practical example.

Let’s say you want to buy a home with an estimated value of $ 200,000 with a 30-year mortgage.

To avoid PMI, you will have to put down at least $ 40,000.

Instead, you decide that you will accept the PMI requirement and go with a $ 20,000 (10%) down payment for a conventional mortgage loan because you have other uses for the remaining $ 20,000.

Since PMI is about 1% of the loan value per year at the high end, your PMI exposure for the first few years per year will be around $ 1,800 with a 10% down payment. This will add about $ 150 to your monthly payments.

If your home’s valuation value rises by 15% in a strong market over those two years, the PMI requirement could be dropped.

You will be out of your pocket for $ 3,600 in PMI payments, but you kept $ 20,000 in your pocket for other investments or uses. Investing at a meager 3%, you would actually realize a profit in net worth.

2. To increase the chances of qualifying for a home purchase and loan

Whichever way you try, it may be impossible for you to save enough money for a 20% down payment on a reasonably priced home. And when the average mortgage rate rises, it becomes even more challenging.

It can be very frustrating when you know you can handle mortgage payments, but the lack of an adequate down payment keeps you out of the home buying market.

Good news! If you can cover mortgage payments (according to the borrower and your budget) and are willing to pay the PMI, it can open the door for you to move forward and buy a home in accordance with the amount of installment you pay at a competitive mortgage rate.

The lender feels protected, and you get the chance to move into the ranks of a homeowner.

Read: Single Family Home Vs. apartment or townhouse as your primary residence (what is best for you?)

Is there a way to avoid PMI with a down payment of less than 20%?

The answer is yes, it is possible. Known as “piggybacking”, the process will require you to use two lenders to finance one home.

The first lender will lend you 80% or less of the home’s value. This keeps their exposure below the 80% LTV threshold.

A second lender will come in to borrow the remaining portion minus any down payment you wish to make. Theoretically, the proceeds for the second loan would pay the deposit requirement on the first loan.

The downside of piggyback loans is that the second borrower is likely to charge a high interest rate for their risk.

This could mean paying out hundreds of dollars more in the long run. You will need to calculate the different loan options to determine if you will pay more interest or PMI.

Final Thoughts

PMI comes at a price, but it can also give you the ability to become a homeowner sooner rather than later.

Do the math, then weigh the pros and cons of paying PMI so you can make an informed decision about whether it’s right for you.

Next: How To Buy A Home: From Views To Closing

Vicki Cook and Amy Blacklock

Amy and Vicki are the co-authors of Estate Planning 101, of Adams Media, from avoiding experimentation and assessing assets to drafting prescriptions and understanding taxation, your essential basis for estate planning.

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