What is Private Mortgage Insurance (PMI) and Why Do You Need It?
If you are applying for a conventional mortgage to purchase a home and have a down payment of less than 20%, your lender may require you to have private mortgage insurance (PMI). Low down payment mortgages are somewhat risky for lenders, because they believe you are more likely to default on a loan in which you have very little invested. For this reason, lenders generally require PMI if you are borrowing more than 80% of the value of the home you are purchasing (i.e., your down payment is less than 20%).
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. PMI premiums are often paid to your loan servicer along with your monthly housing payment (principal, interest, taxes, and insurance). Although PMI can be expensive, you may be unable to qualify for a mortgage without it.
Can PMI Ever Be Removed?
If you are concerned about taking on PMI payments, keep in mind that you may not 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 once you have reached the midpoint of your loan's amortization schedule, provided you have a good payment history. Or, you can petition your lender to remove the PMI if you have a good payment history and reach 20% equity in your home.
Tip: The FHA has special rules regarding the cancellation of mortgage insurance premiums for loans with a loan-to-value ratio greater than 90%. For more information on FHA loans visit the U.S. Department of Housing and Urban Development website at portal.hud.gov.
Are There Any Alternatives to Paying PMI?
If you don't have at least 20% for a down payment, there are a couple of alternatives to paying PMI. Consider asking if your lender is willing to increase your mortgage interest rate rather than require PMI coverage. Your monthly payment will increase by roughly the same amount as the monthly insurance premium. However, mortgage interest is generally tax deductible, whereas PMI payments are not. Moreover, if you're able to make prepayments against your mortgage principal, you'll save on the total interest charge you'll pay over the term of your mortgage.
Caution: With this arrangement, you'll pay the interest for the life of the loan. In contrast, you can generally remove PMI once you obtain a certain amount of equity in your home.
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 (e.g., 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.
Caution: 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.
When you finalize the purchase of your new home, call a Farm Bureau agent to ensure that you and your investment are protected.