You’ve finally done it! You’ve searched your market for the perfect house, settled on the price, put together the down payment and signed all the necessary paperwork. But when you go to apply for a mortgage, you’re told you need “Private Mortgage Insurance”, known as PMI.
Why would you need insurance for your mortgage?
When you apply for a mortgage, the lender will need to cover their own interests and know that you, the person buying a house, will pay back your loan. Lenders gain a pretty good sense of whether a person can pay back their loan based on how much the buyer is able to pay in cash upfront towards their new house. This is called your down payment. If your down payment is less than 20%, most lenders will require you to have PMI as a way to cover their losses in case you stop paying.
So, how do you know if your down payment is less than 20%? Well, this takes just a little bit of math. Let’s say that the house you are buying is $200,000 and you put down $10,000 upfront. That would equate to a 5% down payment. In comparison, if you put down $40,000 instead, you’ll have made a 20% down payment. From the mortgage lender’s perspective, the buyer who makes a 5% down payment appears riskier than the one who pays 20% because they don’t have as much cash on hand, and therefore may have more trouble making the monthly payments.
You may be thinking, “Why would I want to pay into an insurance policy that only benefits the lender instead of me, the borrower?” In truth, PMI could benefit you! By agreeing to have PMI, you can choose to make a down payment lower than 20%, which may ultimately be the difference that makes it possible for you to purchase a home. PMI may appear to only benefit mortgage lenders, but in actuality, it allows them to accept borrowers that can only afford small down payments, making home buying more accessible for millions of Americans.
Before we dive any deeper, there are technically two kinds of mortgage insurance that you should be aware of: mortgage insurance premiums and private mortgage insurance. Mortgage insurance premiums or MIPs apply to FHA and VA mortgages. PMI applies to conventional mortgages that are done with private companies. Because FHA and VA loans are insured by the government, they don’t need traditional PMI like conventional loans do.
Like other forms of insurance, PMI isn’t the same with every mortgage lender. Here are a few things to keep in mind when considering your PMI options:
- Do Your Due Diligence: If you accept the first mortgage offer that a lender provides for you, then you’ll never know if you could qualify for a lower rate with a different lender! PMI works the same way. We recommend considering several options when it comes to your mortgage loan and your PMI. Check with different lenders to compare rates.
- Is It Necessary: Check that the type of mortgage you are applying for is a conventional mortgage. If you are considering an FHA or a VA loan, then the mortgage shouldn’t require PMI.
- Avoiding It: If you can afford a 20% down payment, you’re more likely to find lenders that won’t require you to have PMI. A lower priced home or contributing more money from your savings can help you reach a 20% down payment.
- Ask Around: It’s also possible to work with a mortgage lender to see if they’ll avoid the mandatory PMI. In exchange, they may place higher premiums and interest rates on the mortgage. It’s a good idea to do the math though, as it’s possible that the higher interest rate could actually lead to a higher overall cost than what the PMI would yield.
Even if you don’t want to pay PMI, it doesn’t have to be a permanent thing. When your mortgage reaches 80% or less of your home’s current value, you can apply to have your PMI removed. You’ll need to be up-to-date on your mortgage payments though!
There are a couple of ways to get your mortgage to 80% of your home’s value. You can make extra payments each month, or your home’s value may even increase if you live in a hot real estate market.
If your mortgage is less than 80% of your home’s value, you’ll need to provide a written request to your mortgage lender requesting that they eliminate your PMI. They’ll work with you on having your home appraised to double check that the mortgage is at or below 80%. Once all that is done and approved, your lender will be able to terminate your PMI.
Private mortgage insurance is just another common part of the home buyer’s journey. So now that you know about PMI, the first step is to determine if it applies to your situation. If it does, go ahead and shop around to get the best rate possible. You’ll be well on your way to buying your home in no time.