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The Extra Cost of Private Mortgage Insurance
If you are putting down less than 20% of the value of your new home, you are required to pay private mortgage insurance (P.M.I.) which can cost well over a thousand dollars a year.
This page:
• Defines what private mortgage insurance is
• Explains why you have to pay for it
• Tell you how you can avoid it
We have yet to discuss one time closing costs and various recurring costs. If you've missed it, in the previous pages we've covered interest rates, points and rebates (what are they?), and your down payment. You can start from the beginning of our mortgage package section for a look at all costs and fees.
If you missed it, the first part of this Mortgage Basics guide explained what a mortgage is, how interest rates are set, and how the differences between various mortgage types affect you.
Will you have to pay private mortgage insurance?
Lenders require that you pay for private insurance on your mortgage if your down payment is for less than 20% of your new home's value.
Financing a home purchase is a very expensive business. If a borrower defaults on a home loan early in its term, the lender often loses money on the transaction even if it forecloses on the home and resells it. If this happens enough times, the lender goes out of business. PMI is a policy that protects the lender from losing out on its investment in case the borrower defaults on the mortgage.
Why 20%? Studies show that this is an important point for normal prime borrowers. After a home buyer has paid for a fifth or more of their home, they're much less likely to default on the loan and risk losing all of their investment. PMI protects the lender during that risky up-to-20% period.
How does this affect you, the home buyer? As the borrower, you must pay the premiums on the PMI policy for as long as the lender requires coverage (even though PMI is an insurance policy for the lender and does not protect you at all).
PMI is usually canceled when the principal balance is down to a certain percentage of the home's original value. This may take longer than you would expect, however, because at the beginning of a mortgage program most of your money goes toward interest, and equity is built very slowly.
Lenders usually cancel PMI automatically after you've reached 20% equity in your home (that is, your remaining balance is for 80% or less of the home's cost). The amount you pay annually varies with the price of your home, the amount of the mortgage, and the state that you buy in.
Generally, the yearly payments are about ½% of the loan's total value. Payments may be made in a lump sum or spread out over the course of the year. You pay PMI into an escrow account.
Sidebar
As you can see, whether or not you'll pay PMI is a big factor when considering how much to put down on your mortgage. If your credit is good, get pre-qualified at Eloan to learn how much you can save with various combinations of interest, points, and money down. If your credit is not so hot, FullSpectrum Lending will pre-approve you in minutes for credit building loan designed to get rid of PMI as fast as possible.
Lenders cannot require mortgage insurance if your down payment is equal to 20% or more of your new home's value, and they must cancel coverage when the LTV (loan-to-value ratio) on your mortgage reaches 78%.
They must also notify you at the time of funding the amount of months you will be paying PMI. Some lenders may allow you to avoid PMI by paying a higher interest rate on your loan, but this can end up costing you more if you keep your home for more than a few years.
Lenders are allowed to require subprime borrowers to pay for private mortgage insurance until they have built even more than 20% equity, sometimes up to 50%. Some subprime lenders simply roll this cost into a higher interest rate. Usually this means an additional ¾ to 1 percentage point ( .75%-1%) of interest per year.
This is not necessarily a bad thing for the borrower, because interest is tax deductible and PMI isn't. It can reduce the burden of paying for PMI longer.
The sub prime lender we recommend, FullSpectrum does not charge for PMI separately, instead the cost is included in the interest rate charged.
While this makes your total interest bill higher, by up to ¾ to 1 percentage points (.75%-1%), interest is tax deductible and PMI is not, so you'll save that money on deductions.
Next: One time closing costs
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