PMI Basics
When taking out a conventional loan, most lenders require that the borrower pay for private mortgage insurance (PMI). This is in order to protect the lender from losses in case you, the borrower, can no longer make payments and default on the loan. The PMI is then used to reimburse the lender.
PMI is normally paid monthly, but in some cases there is an option to make a large upfront payment. The amount depends on the down payment made on the property as well as the borrower’s credit score, and is usually between 0.3 and 1.5 percent annually. If your down payment is less than 20 percent of the purchase price, PMI is almost always required since the lender stands to lose more in case of foreclosure.
There are ways for you to avoid paying the PMI on your mortgage:
- Make a down payment of at least 20 percent of the mortgage.
- If your loan-to-value ratio drops lower than 80 percent, you don’t have to pay for mortgage insurance. Depending on your payment habits, this can take a few years.
- You may be able to opt for lender-paid mortgage insurance, where the interest rate is adjusted to include the PMI. This raises your interest payments for the life of the loan.
How Much does PMI Cost?
How much can you expect to pay? Premiums vary. Factors that affect cost include the type of mortgage, your credit rating and the amount of your down payment. Generally, you can expect PMI to be about 0.5 percent of the loan amount. Here is an example using that percentage assumption. Let’s say the home value is $200,000 and you make a 10 percent down payment. PMI would add approximately $75 per month onto your mortgage payment.
Be sure and ask your lender to shop around for the lowest cost PMI. Rates vary depending on your credit status, the size of the loan, and how much money you are putting on a down payment. Just like auto or homeowner’s insurance, different insurance carriers offer different rates. Ask your lender for more information in PMI rates.
Is PMI tax deductible?
While mortgage interest on your home loan is deductible from your federal taxes, the premium for Private Mortgage Insurance is not.
How Can I Avoid Paying PMI?
Unfortunately most home buyers will end up paying for PMI insurance. There are a few ways you can avoid paying PMI.
- Pay at least 20% down payment on a conventional loan – If you can save up at least 20% down payment for your home you will be able to purchase it without paying PMI using a conventional loan.
- Finance with a conventional loan and only pay PMI until loan balance drops to 80% of purchase price – Even if you can’t afford 20% down payment initially, if you are able to afford a conventional loan, you only have to pay PMI on the loan balance until you achieve 20% equity in your home. Then your payments will drop substantially since you don’t have to pay PMI insurance each month. Or you could pay the same amount each month and now the money you WERE paying for PMI can go directly to your loan balance. This would be the smart move, since you will pay your loan balance off much sooner with less interest costs.
- Finance with a Section 184 Native American loan – If you are an eligible tribal member in Oklahoma, you may qualify for a low-cost HUD Section 184 Native American loan. Since Oklahoma is “Indian Country” there are a number of lenders who provide these somewhat unusual and highly desirable loans to eligible tribal members. Since this is a government backed program there is no PMI insurance required, hence lowering the overall cost of the loan, especially for first time home buyers. Luckily, one of the largest Section 184 loan origination banks is right here in Oklahoma at Bank2.
NOTE: One reason I am familiar with Section 184 loans is my husband James and children are all members of the Cherokee tribe in Oklahoma.
Do I have to pay PMI with an FHA loan?
Technically that is correct. Instead of paying PMI until your equity reaches 20% of the loan balance, FHA requires buyers to pay something called FHA MIP – basically the same thing as PMI, but funded through the government versus private insurance companies. The downside of MIP is that it is for the life of the loan rather than until you reach 20% equity. Like PMI, MIP is not tax deductible and is added to your monthly payment. And unlike PMI, MIP is for the life of your loan. The only way to get rid of paying MIP on your loan is to refinance the loan once you reach 20% equity, but then you have to pay loan origination fees.
So is PMI and MIP bad?
Not at all. Many homeowners, especially first time home buyers, would not be able to afford their own home without paying PMI or FHA MIP. These programs allow buyers to start building equity much earlier – but at a cost. A buyer must weigh their ability to save a 20% down payment versus the cost of paying rent while they save the money. Oftentimes buyers are able to avoid PMI and MIP on their second home purchase once they have built up equity in their first home.
