When you buy a home, it’s likely you’re making the biggest purchase of your life. And, for most people, it’s a purchase that needs to be financed. For lenders, issuing a loan that covers the cost of a home is a big risk. A down payment helps mitigate that risk by lowering the amount of the loan and demonstrating to the lender your ability to manage your finances and save money. The bigger the down payment, the better.
But what if you’re not able to provide a large down payment? That’s where private mortgage insurance (PMI) comes in.
What Is Private Mortgage Insurance?
Private mortgage insurance (PMI) is a type of mortgage insurance that is paid to a lender as a condition of a home loan — specifically, when the borrower has less than a 20% down payment. Lenders view low down payments as riskier because they believe you are more likely to default on a loan when you have less invested.
How Much Does PMI Cost?
PMI premiums vary depending on the insurance company, but they are usually based on factors such as the type of mortgage loan and the loan amount. For conventional loans, PMI premiums typically range from about 0.2-2% of the amount of the loan. PMI premiums are often paid to your loan servicer along with your monthly housing payment (principal, interest, taxes and insurance).
How Long Do I Have to Pay PMI?
Nobody wants a bigger monthly payment than is necessary. But there is good news — you likely won’t have to pay PMI forever. For loans originated after July 29, 1999, your lender is obligated to cancel your PMI when the principal balance on your loan is scheduled to reach 78% of the original value of your home or when you reach the midpoint of your loan's amortization schedule — if you have a good payment history. You can also petition your lender to remove the PMI if you have a good payment history and reach 20% equity in your home.
Are There Alternatives to Paying PMI?
If you don't want to pay PMI, there may be alternatives. Here are some options to consider instead of paying PMI.
Increased Interest Rate
Consider asking your lender if they’re willing to increase your mortgage interest rate rather than require PMI coverage. While your monthly payment will increase by roughly the same amount as the monthly insurance premium, paying a higher mortgage interest could provide an added benefit: Mortgage interest is generally tax deductible, whereas PMI payments are not. Likewise, making prepayments against your mortgage principal means you’ll save on the total interest charge you'll pay over the term of your mortgage.
On the other hand, you can generally remove PMI once you obtain a certain amount of equity in your home, whereas you'll pay the interest for the life of the loan.
Another alternative to paying PMI is 80-10-10 financing (also known as piggyback financing). With this type of financing, a lender provides a traditional 80% first mortgage. You then obtain a 10% second mortgage and make a 10% down payment. Keep in mind that 80-10-10 financing can be altered to accommodate the size of your down payment (for example, you could put 8% down and obtain 80-12-8 financing). However, the lower your down payment, the higher the loan fees and interest rate may be.
Although the mortgage interest you pay is generally tax deductible, the initial and ongoing costs of these arrangements may be higher than your PMI payments would be, particularly if you put less than 10% down.
Protect Your Investment
When you finalize the purchase of your new home, call a Farm Bureau agent to ensure that you and your investment is protected.