Private Mortgage Insurance: Friend or Foe?

what is PMI

You either got to this article from a Google search or you clicked through because you are freaked out about the extra money you will be required to pay if you make less than a 20 percent down payment on your first home. But don’t worry, PMI is actually pretty cool.

So, what exactly is PMI and why does it exist?

PMI (an acronym that stands for “private mortgage insurance”) is simply a way for a lender to protect its investment (i.e. the money it is loaning you to buy your home).

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Why is this fee necessary? Unfortunately, a lot of people who buy homes can’t afford them and end up foreclosing because they can’t make their mortgage payments. Properties land in the hands of the bank, which could lose money if homes appraise for less than what borrowers owe on them. Banks don’t like losing money, so they pass the risk on to borrowers at the get-go by charging PMI to insure mortgages.

How much does PMI cost and how do I pay for it?

PMI is offered through an insurance company, so the price varies, depending on the company and the size of the mortgage. But typically, the monthly fee is 0.5 to 1 percent of the total loan amount or between $50 to $250, depending on the size of the mortgage. It definitely add ups, so make sure you calculate how much money it’s adding to your mortgage per year when analyzing whether it’s worth it or not.

Most PMI ends up getting baked into your monthly mortgage payment, but you should see it broken out as a separate line item on your statement. While many lenders will let you shop for your own PMI, it’s often just easiest to work with the PMI company your lender recommends. Any savings you can find likely won’t be worth the effort to comparison shop. But if you are unsure, get a couple of your own quotes to see if you can save any money.

If your house goes up in value (appreciates) quickly and you end up having at least 20 percent equity in the home, you can request that your mortgage lender remove PMI.

Why is PMI your friend and not your enemy?

PMI gets you in a home without first having to save up a 20 percent down payment. In many cities and by working with the right lender, buyers with good credit can put down as little as 1 to 5 percent of the home’s purchase price. In most cases, PMI is a small price to pay to be able to buy a home you love and invest in real estate. If you wait until you have 20 percent, you may be completely priced out of your favored market.

How can you get rid of PMI?

Another cool feature of PMI is that (in the case of conventional loans) it’s temporary. You no longer need to pay PMI once you have 20 percent equity ownership in your property. In fact, in some cases, if your house goes up in value (appreciates) quickly and you end up having at least 20 percent equity in the home, you can request that your mortgage lender remove PMI. In most cases, this requires that you have the property re-appraised (which in most markets costs about $500 — a small price to pay if your home has gone up in value and PMI can be wiped).

In some hot markets, like Las Vegas and San Francisco, this can happen in a year or less. Another way to get rid of PMI is to refinance your mortgage once the home has gone up in value. Or pay as much as you can on your mortgage until you own 20 percent of the value.

PMI can help you put less money down and buy your first home faster. While every situation is different, it’s often worth it.