Private mortgage insurance may not look like a significant monthly cost, but it’s one you can avoid. Here’s why you should.
If you’re in the market for homes for sale in Charlotte, NC, and have started talking to lenders, you may have come across these three little letters: PMI. “PMI” stands for “private mortgage insurance.” This is an additional fee, on top of your principal and interest, escrow, and taxes, that you might be required to pay each month.
PMI is used with conventional loans and is a type of insurance that protects the lender in case a borrower defaults on the loan. The institution underwriting the mortgage handles the insurance, but the borrower pays the premium. Private mortgage insurance does nothing for you as the homeowner and can cost you as much as $50 to a couple of hundred bucks per month. And it’s not necessarily a required expense! Here’s why you should avoid taking on PMI.
You don’t have to pay PMI
Private mortgage insurance is not a mandatory cost for all homeowners. Lenders charge PMI when you finance more than a certain percentage of the home purchase. Most of the time, your lender will impose PMI when you put down less than 20%. It doesn’t matter how good your credit score is or how financially responsible you look on paper. The insurance is intended to protect the lender in case the borrower defaults on the loan (financial institutions view mortgages made for more than 80% of the home’s value as inherently higher risk than those made for less). A general rule of thumb? Avoid PMI with a bigger down payment, and expect to pay it if you put down less than 20% of your home’s purchase price.
Private mortgage insurance does nothing for you
Paying for private mortgage insurance is just about the closest you can get to throwing money away. This is a premium designed to protect the lender of the home loan, not you as a homeowner. Unlike the principal of your loan, your PMI payment doesn’t go into building equity in your home. It’s not money you can recoup with the sale of the house, it doesn’t do anything for your loan balance, and it’s not tax-deductible like your mortgage interest. It’s simply an additional fee you must pay if your home-loan-to-home-value ratio is less than 80%.
It’s difficult to get rid of
Most of the time, you build equity in your home over time as you pay down the principal of your mortgage. Even if you financed more than 20% of the purchase price of your home, eventually you should pay down enough of your loan so that you owe less than 80% of your home’s original appraised value. When this happens, PMI drops off. At least, that’s how it’s supposed to work. But it’s often not that easy and straightforward for homeowners. Removing PMI isn’t always automatic, and you may need to request that this fee be removed from your monthly mortgage payment. Some lenders require homeowners to send in documentation and get a formal home appraisal before they’ll remove PMI. Other lenders won’t automatically drop PMI until your loan balance hits 78%. But you can send in request to drop it when you hit 80%.
PMI isn’t tax-deductible
If you itemize your deductions when you file your tax return, you can take advantage of the interest you pay throughout the year. Mortgage interest payments are tax-deductible, which makes paying that fee just a little more bearable for homeowners looking for whatever tax breaks they can find. The same cannot be said for private mortgage insurance. If you’re thinking you can use a smaller down payment and “make it up” with a tax deduction on the PMI you’ll have to pay as a result, think again. PMI is not tax-deductible, no matter how you file.
How can you avoid paying PMI?
The easiest way to avoid private mortgage insurance is to put down at least 20% when you take out a home loan. A larger down payment not only helps you avoid PMI but also saves you money over the life of your loan. You’ll borrow less money, which means paying less in interest and having a lower monthly mortgage payment. Not to mention, you’ll have more equity in your home right away.
You can also look into different types of home loans. But even if they do not require PMI, they may have other fees. For example, government-backed loans, like VA and FHA loans, do not require private mortgage insurance. However, VA loans will likely require a VA funding fee, which ranges from 1.5% – 3.3% of the loan amount. And FHA loans will require both an upfront mortgage insurance premium (UFMIP) of 1.75% plus a monthly mortgage insurance premium (MIP) of 0.85%. So be sure to talk to your mortgage lender about all of the options available to you, and request loan estimates so you can compare the total cost of each loan.
Have you avoided private mortgage insurance? Share your experiences and tips in the comments!