For most borrowers PMI (or Private Mortgage Insurance) is just one of the many mysterious charges that get folded into their total monthly mortgage payment. But anyone in the market for a new home, and the inevitable mortgage that comes with it, needs to understand how it works, and how it can be avoided. Simply put, PMI is an insurance policy that your lender takes out as protection against the possibility that someday you will no longer be able to make your mortgage payments, except that it is your responsibility to pay the monthly premiums. Also, the lender is typically the beneficiary, not you or your heirs.
Not everyone has to pay for PMI, however. Anyone who makes a down payment of more than 20% of a home’s value on a conventional mortgage —that is non-FHA-insured — can avoid paying for PMI coverage. For those who can’t make a 20% down payment, the PMI policy can be cancelled once the outstanding balance on your mortgage drops below 80% of the value of the home you are borrowing against. At 78% of equity, it is usually cancelled automatically. This percentage can be reached through payments against principal and by increased market value. But to determine the market value the lender may ask to have an independent appraisal done.
The monthly cost of the Private Mortgage Insurance each borrower has to pay varies according to the amount of the loan, the loan-to-value ratio, and the borrower’s credit score. Usually the rates for PMI run from about .5 percent (0.005), for someone with a FICO score above 760, to 1 percent (.001) or more of the principal per year, for those with lower scores. On a $200,000 mortgage that can cost the borrower between $83 and $166 per month in additional charges, or $1,000 to $2,000 per year, not an insignificant amount.
The calculation that anyone thinking about buying a home has to make is whether it is worth spending the money now for PMI in order to take advantage of low interest rates and moderate home prices or to wait until they have the magic 20% down payment in hand. Borrowing against one’s retirement plan or savings to cover a down payment is never considered a good idea, so it may mean biting the bullet and paying for the insurance, looking for an FHA-insured loan or economizing a little bit longer to accumulate the necessary 20%.
The good news is that for many people the payments on PMI are tax deductible, that is if you as a couple together have a gross adjusted income of less than $110,00, although that threshold may be raised in the future.
Litchfield Branch Manager, Vice President
NMLS MLO ID: 698742