What is Private Mortgage Insurance and How it Impacts Your Home Loans

private mortgage insurance
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It doesn’t matter who you are, when having to make a mortgage payment with principal, interest, property taxes, and home owners insurance, the last thing you want to do is add another fee to our already growing monthly expenses.

Unfortunately, when we borrow money from the banks and put a low amount down we are often faced with having to pay for private mortgage insurance.

What is Private Mortgage Insurance?

Private mortgage insurance or PMI is a fee that borrowers pay to insure the banks if we default on our conventional loans.

Think of it like an insurance policy for the bank. As a borrower if I default on my loan amount then this fee (PMI) protects the lender.

Typically you will see a mortgage lender require PMI on a conventional loan with a down payment amount under 20%.

The good news with conventional loans is that the closer to the 20% threshold you get (with your down payment) the less you have to pay and the better your credit score the less you have to pay.

Naturally the more money you put down on a property the more protected the banks feel and don't require as much insurance. So with a conventional loan if you put down 20% you won't have to pay the fee.

When it comes to financing using an FHA loan things are slightly different because of it being a government loan product.

For instance, if you choose to buy a home using an FHA loan (which usually allows you to put less money down) you will be required to pay this mortgage insurance premium as insurance.

How Mortgage Insurance is Structured

There are three ways in which PMI (with conventional loans) can be addressed when structuring your loan:

  • You can pay it monthly- It is more expensive but allows a lower interest rate.You can pay it up front - Borrowers receive a discount for “paying in full” however, you do not get a refund if you reach the 22% equity in 2 years. You paid it so it’s gone.You can roll it into your interest rate - When you roll it into the rate, you will have a higher interest rate, but you will have a better tax deduction because the interest that you pay on a mortgage is tax deductible. If you choose to roll your PMI into your rate, you take a higher rate, but that means your deduction is higher. For instance, if you chose to pay monthly PMI with a rate of 4%, you would not be able to get your PMI deducted. But if you roll it into you rate and so your PMI and rate equals 5%, the total 5% (rate and PMI) becomes tax deductible.

When borrowing using an FHA loan you have less choice. As a borrower you are required to pay a monthly fee and also pay an up front mortgage insurance premium that can be rolled into the loan balance.

The thing about PMI is that there are a lot of myths and misinformation out there regarding it’s ugly face. In the following section we will debunk some of those myths and give you options with PMI so that it can fit into your plan.

Myth #1 20% equity enables PMI to be removed

This is a commonly quoted fact that is thrown around in the investing field; however, in order to get your monthly PMI removed you must actually reach 22% equity. Once you reach this equity threshold, by paying down the loan 22%, by law private mortgage insurance companies must remove it meaning there is no appraisal and no refinancing. Some people will try and request their PMI to be removed once they hit 20% equity, but most often the companies do not allow it.

Myth #2 If the value of the property goes up you reach higher equity quicker

Unfortunately, if you buy a home today and next week it goes up in value $50,000 that is not going to help you in terms of equity and the removal of your PMI. Insurance companies base the PMI off of purchase price, meaning current market property values do not weigh in on the equity established.

**Tip**

If you are going to refinance consider how close you are to getting your PMI removed versus the costs associated with refinancing. If you only have 2 years left of PMI and it totals $2,400 and the refinancing costs come to $5,000, it may be better to wait those 2 years because the money going into your PMI is less than the refinancing costs.

Be cautious:There are some mortgage insurance companies that will not only require a certain amount of equity to eliminate PMI, but also require a certain amount of time. For instance, an insurance company may require you to reach 22% equity and five years of PMI payments before you can get rid of it.

Meaning, if you reach the equity threshold in 3 years, you are still stuck paying the PMI for another 2 years to meet both requirements.

 

 

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2 Comments

  • Timmy

    Reply Reply November 4, 2018

    Review other types of loans. While conventional loans are the most popular, they aren’t the only kind. Look at FHA, VA, and other types of home loans to make sure you’re getting the right one for your situation.

    • Emily

      Reply Reply November 8, 2018

      Absolutely Timmy! There are many loan products out there and looking at the different loan types can definitely help you in your situation!

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