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You sit in the lobby. The news is just too much to bear so you stand up and pace the hallways, awaiting the outcome. Your mortgage lender meets you halfway down the corridor, and with solemn eyes says, "Sir, I regret to inform you that you will have to pay PMI each month." You drop to your knees when you hear this information, and then ask, "What is PMI again?"
What is PMI?
PMI stands for private mortgage insurance. It is generally required when you purchase a home with less than a 20% down payment. Actually, about 60% of first-time home buyers have to pay PMI – and were therefore unable (or unwilling) to make a 20% down payment. So being diagnosed with having to pay PMI is something that is far more common than you think.
Your PMI is a fee added every month in addition to what you pay for your principal mortgage amount (including interest), as well as other fees such as property taxes and homeowner's insurance. Here is an example of how much PMI payments may add to your monthly total compared to applying a 20% down payment. Let's assume we have a property valued at $300,000, with a 4.25% interest rate on a 30-year fixed mortgage.
- 20% down payment ($60,000): monthly mortgage payment of $1,548.
- 5% down payment ($15,000): monthly mortgage payment of $1,950.
Now, why does the second scenario yield a nearly $400 higher monthly payment? It's two-fold. First, the principal amount (and interest) is higher; in this case, it is about $221 more a month. Second, the estimated PMI adds an additional $181 a month as well. The average range of PMI premium rates is about 0.55% to 2.25% of the original loan amount per year.
Some Exceptions to PMI
Now that we have covered the basic nuts and bolts of PMI, here are some caveats and exceptions to the 20% down payment rule. Some loan providers may offer you a low down-payment/PMI-free loan. However, you may end up paying a higher interest rate as a concession. There are also other loans, such as ones backed by Veterans Affairs for eligible borrowers (i.e. qualified veteran or active duty service members), where PMI is not required. Federal Housing Administration ("FHA") backed loans may require a different type of mortgage insurance (usually paid upfront or on an annual basis) which is usually lower than PMI. FHA loans often have more lenient down payment requirements, but the mortgage insurance requirement may exist for the life of the loan.
So Here's the Scoop
If you are unable to make a 20% down payment or cannot be approved for a VA/FHA loan, do not despair. There are a few reasons why having to pay PMI should not be considered a deal-breaker:
- The PMI requirement is finite. Most lenders will allow several methods of paying PMI: monthly, annually, or a combination of both. Most borrowers elect to add the PMI amount with their monthly mortgage payment. Once you have reached the magical 20% equity line, you can ask your loan provider to remove the PMI requirement. Loan providers are obligated to terminate PMI once your loan balance reaches 80% of the property's original value.
- PMI can be considered a temporary bridge that helps the borrower buy a dream home that would otherwise be out of reach if a 20% down payment was a mandatory requirement. Yes, you must pay an additional expense in the form of PMI, but again, this is temporary. In some cases, the ability to build equity faster may outweigh the cost of the PMI.
- PMI remains tax-deductible in 2020 thanks to the Further Consolidated Appropriations Act of 2020 (available here for those who enjoy reading IRS legislation).
There are many factors to consider when you are faced with the possibility of having to pay PMI in addition to your monthly mortgage payment. Our team can help walk you through your options. At Bydand, it is our mission to provide steadfast solutions tailored to accomplish our clients' home financing goals. We'd love to help you get into your dream home. Just give us a call at 877-306-0222.