Private Mortgage Insurance- The Good, The Bad, and The Ugly

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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 we want to do is add another fee to our already growing monthly expenses.  Unfortunately, when we borrow money from the bank we are often faced with having to pay a PMI (private mortgage insurance).

What is it?

PMI or private mortgage insurance is a fee that borrowers pay to insure the banks if we default on our loans.  With a higher down payment of 20% this gives the bank a cushion if we were to default on our loan.  Anything less than that doesn’t provide enough cushion and requires this PMI fee. Naturally the more money you put down toward 20% the less the PMI fee is. Even better, if you put down 20% you don't even have to pay it.

There are three ways in which PMI 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.

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 house 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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