Private Mortgage Insurance (PMI) may seem like another cost on your mortgage statement, but in many cases, it’s a win-win situation for you and your lender. PMI benefits homebuyers by enabling them to ship sooner, increase their purchasing power, and expand their cash options for home improvements.
Buying a home can be a daunting process, even for the savviest buyers. It is the most significant financial investment they will ever make for most.
At the time of application, buyers may experience a shock of high costs when they see the variety of fees, additional costs, and taxes added to the mortgage payment. One of these additional costs may be private mortgage insurance (PMI).
Private mortgage insurance is generally required on conventional loans with less than 20 percent down payment. It provides the lender with financial security if the borrower defaults and goes into foreclosure.
“PMI may seem cumbersome to many, but it benefits many borrowers,” said Sue Osterman, manager of retail mortgages for the Cleveland East market at PNC Bank.
Private mortgage insurance allows buyers to buy a home sooner, increase their purchasing power and expand their cash options because they can put down less than 20 percent.
Many homebuyers stretch their down payment budget to put down 20 percent to avoid PMI, but Osterman says this isn’t always advisable.
“Typically, the biggest hurdle to homeownership has enough money for a down payment and closing costs, and most first-time homebuyers haven’t saved enough to put down the full 20 percent. percent,” said Osterman, a 35-year veteran of the mortgage industry. “On the other hand, for a more experienced and savvy borrower, it may make more sense to put down less and leave your investments in place, earning a higher rate of return and principal.”
PMI also expands cash options, which can allow for home improvements.
“How many homebuyers can say they have a perfect, move-in ready home?” Osterman said. “By putting down less than 20%, buyers can use any remaining cash toward home improvements to make their purchase truly the home of their dreams.”
Specific PMI details
A popular consumer misconception is that buyers can buy their own PMI; however, because you are insuring the lender and not the borrower, PMI is not available for purchase. Like life insurance, PMI is based on risk.
The price of PMI depends on the financial situation of the borrower, specifically the following four main factors, which contribute to the monthly cost:
- Product type (fixed or adjusted rate)
- Loan-to-value (LTV) ratio
- Borrower’s credit score
- Loan term (15 years, 30 years, etc.)
Most do not know that PMI can also be paid in advance. Called lump sum mortgage insurance, buyers pay a lump sum at closing. Depending on the situation, this can also be paid by the seller. Therefore, PMI is not added to the monthly payment.
In the sidebar example, for the first ten years, paying a lump sum at closing would cost approximately $2,900; however, adding the monthly premium over that same period comes to $8,100.
“In addition, there is the PMI paid by the lender. The PMI is built into the interest rate, which means a slightly higher interest rate, but no monthly PMI is added to the borrower’s monthly payment,” said Osterman, who worked for a PMI company for 17 years before joining PNC in 2013.
The less money you initially put in, the higher the premium rate. And the shorter the term, the lower the premium.
The good news is that the PMI is not forever. If a borrower has a conventional loan, the monthly premium eventually disappears. By law, lenders must automatically cancel PMI once a buyer reaches 78 percent of the home’s original appraised value.
For first-time homeowner (FHA) loans, the term is Mortgage Insurance Premium (MIP), which is backed by the government and is required regardless of the down payment. The difference is that the MIP is required during the loan term.
The moment is now
With his long tenure in the mortgage business, Osterman has seen the fluctuations of the housing market and generations of homebuyers. He says there’s never been a better time to buy a home, especially for young adults, with the economy running smoothly.
“When I see mortgage rates now, hovering around 4 percent, I’m shocked because I can still remember the first loan I took out in 1981, which was 17 percent, adjustable, with no limits. We did everything by hand; there were no fax machines or computers. We live in good times.”