Private Mortgage Insurance (PMI) is a type of insurance that is often required for home buyers who are putting down less than 20% as a down payment on their mortgage. It is designed to protect the lender in the event that the borrower defaults on their loan. While PMI can be a helpful tool for those who cannot afford a large down payment, it is important for borrowers to understand the costs associated with this type of insurance.
PMI Calculation:The first thing to understand about PMI is how it is calculated. PMI is typically a percentage of the loan amount and can range from 0.5% to 1% of the total loan. This means that for a $200,000 mortgage, the annual PMI cost could be anywhere from $1,000 to $2,000. This cost is then divided into monthly payments, which will be added to the borrower’s mortgage payment.
There are a few factors that can influence the cost of PMI. The first and most obvious factor is the down payment amount. The lower the down payment, the higher the PMI cost will be. This is because a smaller down payment means a higher risk for the lender. Additionally, the borrower’s credit score can also impact the cost of PMI. Those with a lower credit score may be seen as a higher risk and therefore will be charged a higher PMI rate.
It is important for borrowers to understand that PMI is not a one-time fee. It will continue to be a part of their mortgage payment until they reach a certain amount of equity in their home. This is typically when the borrower has paid off 20% of the loan. However, there are some instances where PMI may be cancelled before reaching this threshold. For example, if the value of the home increases significantly, the borrower may be able to request for PMI to be cancelled. It is important for borrowers to keep an eye on their home’s value and their equity to see if they are eligible for PMI cancellation.
In addition to the monthly payments, there are also upfront costs associated with PMI. These costs can include an initial premium payment and an appraisal fee. The initial premium payment is usually around 1.75% of the loan amount and is typically paid at closing. The appraisal fee is necessary to determine the value of the home and can range from $300 to $500. These upfront costs can add up and should be factored into the overall cost of PMI.
One thing that borrowers should also be aware of is that PMI is not tax-deductible. This is different from mortgage interest, which can be deducted on tax returns. This means that the cost of PMI cannot be used as a tax write-off, which can further increase the overall cost of PMI.
For those who are considering a low down payment mortgage, it is important to weigh the costs of PMI against the benefits of a lower down payment. While PMI can make homeownership more accessible, it is important to understand the long-term costs and how it will impact your monthly mortgage payment.
There are a few ways to avoid PMI altogether. The most obvious way is to save up for a larger down payment. This can be challenging for many individuals, but it can save thousands of dollars in PMI costs over the life of the loan. Another option is to consider a piggyback loan, where the borrower takes out a second loan to cover the down payment. This can help avoid PMI, but it is important to carefully consider the terms and interest rates of the second loan.