Understanding PMI & How to Avoid Paying it
As you start shopping for a home to buy, you might hear the term PMI. This term stands for Private Mortgage Insurance. It might sound like something you need and even want, but once you understand what PMI is, you might think about it differently.
What is PMI?
PMI or Private Mortgage Insurance is an insurance policy protecting the lender you choose for your conventional mortgage loan. It's a requirement from most lenders unless you purchase a home with a 20% down payment or with 20% of equity built into the deal.
A Few Basic Things to Understand about PMI
You will likely pay between 0.5% and 1% of the annual mortgage value in PMI when you buy a home with less than 20% down. Sometimes, it will be a part of your monthly mortgage payment, and other times you will pay the PMI amount up-front at closing.
Once you reach a point where you have 20% or more worth of equity built up in your home, you can remove PMI. This means your mortgage payoff amount is 80% or less of the appraised value of your home. If necessary, you can speak with your lender and get a new appraisal to have PMI removed.
The lender will need to be the one to terminate PMI and they must do so when you reach 78% of the original value of the home, according to Investopia. However, you might be able to get it removed sooner if your home goes up in value or you pay extra on your mortgage.
It might be possible to use a smaller loan for your down payment to avoid paying PMI from the beginning. This is known as piggybacking and it does mean you will need to pay two loan payments instead of one.
It's important to understand, Private Mortgage Insurance is not protection for you the home buyer. It's protection for your lender in case you default on your loan and you go into foreclosure.
A Few Other Types of Mortgage Insurance to be Aware of
PMI isn't the only type of mortgage insurance out there. It usually applies to conventional loans, but other types of loans might require mortgage insurance, too.
FHA loans, for example, come with mortgage insurance, no matter how much you put down. On the other hand, VA home loans will never require mortgage insurance, even if you put no money down.
USDA home loans come with two types of mortgage insurance. You will pay an up-front guarantee fee and you will also pay a fee annually with this type of mortgage.
Avoiding PMI with Conventional Home Loans
While you can use the strategy above of piggybacking to avoid paying PMI, you can also pay a down payment of 20% of the purchase price of the home. This can be difficult to come up with, but it's the easiest way to avoid paying Private Mortgage Insurance.
Another option is to find a home you can buy for less than the appraised value. If you can buy a home with built-in equity, you can avoid PMI, if the mortgage you take out has a loan-to-value of 80% or less.
While there's nothing wrong with PMI or paying it when you buy a home, it can be avoided. You should understand what PMI is and why you might need to pay for this type of insurance when you buy a home with a conventional home loan.