As you go through the process of purchasing a home with a mortgage, you are likely to discover a number of surprising costs. Indeed, what you end up paying in the end is usually much more than you might have anticipated when you first started looking for a home. One of the surprising costs that might come up as you sign your closing papers is PMI.
What is PMI?
PMI stands for “private mortgage insurance.” When you get a conventional loan from a financial institution, you might be required to pay premiums for mortgage insurance. It’s called “private” because it is insurance from a private third-party, rather than insurance from the government. PMI is usually paid on conventional loans, which are loans that aren’t backed by the government. If you are getting a “regular” mortgage from a lender, rather than through a program that is backed by the FHA, VA, USDA, or other federal government agency, you might be subject to PMI.
Basically, PMI is designed to pay out to a lender if you default on a loan. You pay a mortgage premium for insurance, and if you don’t make payments on your loan, the lender receives a payout from the insurance company. The idea behind PMI is to reduce the risk to a lender. Remember that the lender is the one putting up the money for your home purchase. If you don’t repay the loan, the lender is the one that loses the most money. When you purchase PMI, you are reducing the risk to the lender.
Do You Need to Pay for PMI?
Not every borrower needs to pay for PMI. However, most borrowers are likely to end up paying PMI at some point. This is because PMI is usually required of someone who doesn’t put down 20 percent for a down payment. Indeed, most home buyers only put down between five and 10 percent. With the economy recovering and many lenders and others willing to take more risks, it’s even possible to get a mortgage with no money down. In these cases, PMI is used as a way to reduce the risk to lenders.
If you have a down payment of at least 20 percent, you are putting a significant amount of your own money into the transaction. Just think: If you are buying a home for $200,000, your 20 percent down payment amounts to $40,000. A lender sees your willingness to commit that much money, and since you would lose that money in the event of a default, assumes that you will work harder to stay up to date on your payments.
When you put down less than 20 percent, you can expect to pay PMI. You might pay between $25 and $80 per month for every $100,000 that you borrow. PMI can be expensive, but if you don’t have the money for a big down payment, it might be worth it to pay the premium if owning a home is important to your financial plan.
When Can You Stop Paying PMI?
As you might imagine, you can usually stop paying PMI once you reach the point at which you have 20 percent equity in your home. So, when you pay off enough of your home loan that your loan to value ratio is down to 80 percent, you can ask that your PMI be cancelled. Federal regulation requires lenders to automatically cancel your PMI, whether you ask for it or not, when your loan to value ratio reaches 78 percent.
If you want to save money each month, it can be worth it to monitor your balance and your home’s value. When you reach the point where you reach a loan to value ratio of 80 percent, you can contact your lender and ask to cancel your PMI. Additionally, even though lenders are supposed to cancel your PMI when you reach a loan to value ratio of 78 percent, some lenders might not catch it soon enough. Keep tabs on your situation and make sure that PMI is cancelled when it should be.
While there are ways to get around paying PMI, they aren’t as available as they have been in years past. If you don’t have enough money to put 20 percent down on your home, be prepared to pay extra each month for PMI.