What is private mortgage insurance (PMI?) How does it affect you as a homebuyer? We’ve put together this short article to help you understand what it is, how much it costs you and how to avoid it.
What is Private Mortgage Insurance?
Just like other types of insurance, PMI exists to protect one of the involved parties in case of a loss. The thing is, it’s not protecting you the homeowner from anything. It’s actually protecting the lender in case you default on your home and the lender has to take ownership of the home.
What makes you have to pay private mortgage insurance? If you get a conventional mortgage – the most common type – and don’t have at least 20% cash as a down payment, you will most likely have to pay private mortgage insurance. You just don’t have enough equity in the home to make the lender able to offer a loan without this extra fee. Their goal is to make money, and if you default on a home without much equity, they may end up losing money on the deal by the time they get the house sold.
How Much Does PMI Cost?
Each loan is different, but rates can range from 0.25% to 2% of the home purchase price per year. It may not sound like much, but it adds up.
For example, let’s say your home cost $300,000. If your PMI is 1% of that each year, you’re paying an extra $3,000 per year, or $250 per month. Could you find something you’d rather spend $250 on other than giving it to your lender as a fee?
After all, you could
- Add it to an emergency savings fund
- Put it towards retirement
- Pay off credit card or student loan debt
- Go out for a few nice dinners
- Buy a used car
That’s why so many people hate paying PMI. It’s a necessary evil for many people, but fortunately there are a few ways to avoid it.
How to Avoid Paying Private Mortgage Insurance
There are a few ways you can get out of paying this fee to your lender.
VA Loans – if you’re in the military or a military veteran, you probably have access to getting a VA Loan. Even though a VA Loan requires a VA Funding Fee when you purchase the home, it doesn’t require PMI. Over the long run, this leads to a lot of money saved.
USDA Loans – if you live in a rural area that’s able to take advantage of a USDA Loan, you won’t need to pay PMI. The tough thing with these is most people in the US don’t live in these rural areas – they live in bigger cities that aren’t eligible.
Piggyback Loans – you may be able to “piggyback” loans, where you get two mortgages. The most common type is an 80-10-10 loan. That means
- The first mortgage is for 80% of the purchase price
- The second mortgage is for 10%
- The homeowner has a 10% down payment
The advantage to this is no PMI. The disadvantage is you have to pay closing costs on both loans, plus the smaller loan may have a higher interest rate.
Get 20% Equity – if you can’t go with one of the options above, your best bet is to get at least 20% equity in the home. It’s not easy to save up that much cash or put the extra principal into your existing home, but the tradeoff will be worth it when you don’t have PMI.
Do you have more questions on PMI, or buying a house in general? Send us an email at Team@RyanGrantTeam.com. We’d love to help.