Buying a home is one of the most significant and exciting investments you can make in your lifetime. However, unless you have a substantial down payment, mortgage lenders will require you to purchase Private Mortgage Insurance (PMI). Private Mortgage Insurance assures lenders of the borrower’s solvency in case they default on their mortgage payments. PMI provides lenders with protection, which promotes issuing more loans to potential homebuyers who would otherwise not qualify due to the lack of a significant down payment.
How PMI Works
Private Mortgage Insurance covers the lender’s financial risk of granting a loan to borrowers who cannot afford a down payment of at least 20% of the home’s purchase price. If the borrower defaults on payments fully or partially, the lender can file a claim against the PMI policy for the designated percentage of the outstanding loan the policy covers.
How PMI premium is calculated
PMI premium rates range between 0.3% and 1.0% of your loan’s original value per annum, jacking up the monthly mortgage cost. They depend on the borrower’s credit score, loan-to-value ratio, and down payment percentage. The PMI premium decreases as the down payment increases, and as you reach 20% in home equity, you can request a cancellation.
The advantages of PMI
While PMI provides lenders with protection for larger loans, it also allows borrowers to purchase homes with as low as a 3% down payment. That means if you are buying a $300,000 home, for instance, with an FHA loan that requires a 3.5% down payment, you can put down $10,500 as opposed to $60,000. Additionally, PMI can be paid off upfront, therefore lowering monthly mortgage expenses.
The disadvantages of PMI
PMI increases the total cost of homeownership. Although PMI is a requirement, it can add up to 1% of the purchase price annually. This means that by the end of a 30-year mortgage term, you could have paid upwards of $36,000 in PMI payments alone. PMI also usually comes with stricter guidelines than regular loans; hence, the application process can be more cumbersome.
How to get rid of PMI
PMI can be canceled once the borrower’s home equity reaches 20% of the original purchase price. Alternatively, borrowers can submit a written request to the lender to remove the PMI once their equity reaches at least 22%. Note that if you have an FHA loan, your PMI can only be terminated if you refinance into a conventional loan.
Private Mortgage Insurance is a crucial tool for borrowers who do not have the ability to pay a high down payment on their homes. PMI assures lenders of borrowers’ financial stability, enabling them to grant loans with lower down payments. Although PMI can increase a homeowner’s total cost of homeownership, it is easy to remove once you reach the requisite equity in your home. Ultimately, it is a vital investment in homeownership that provides homeowners and lenders alike with the requisite security.