Private mortgage insurance, better known as PMI, provides a type of financial safety net to your lender if you should stop paying your mortgage on time. How much you pay will vary, but PMI typically costs 0.1% to 2% of your loan amount.
That can add up. If you are taking out a mortgage of $300,000 and your PMI runs 1% a year, you’ll spend $3,000 a year on PMI. That comes out to $250 a month.
How to avoid PMI
You don’t always have to pay for PMI. Your lender won’t charge you for this insurance if you come up with a down payment equal to or higher than 20% of your home’s final purchase price.
Say you are buying a home for $300,000. If you come up with a down payment of $60,000 — equal to 20% of $300,000 — you won’t have to pay for PMI.
Is it worth it?
Here’s where the possible benefit of PMI comes in. Coming up with a down payment of 20% can be difficult, especially if you are buying a more expensive home. Consider that $300,000 home example: Can you come up with $60,000 to avoid PMI?
Today, you don’t have to come up with such a large down payment. You might qualify for a conventional loan — one not insured by a government agency — with a required down payment of just 3% of your home’s final purchase price.
For a $300,000 home, a 3% down payment comes out to $9,000. That’s not a small amount of money, but it’s far more doable than $60,000.
PMI is what allows mortgage lenders to accept smaller down payments. The extra financial protection provided by this insurance gives lenders the confidence to take on more risk when originating mortgage loans.
When considering your down payment options, you’ll have to decide whether you want to come up with more money to avoid paying PMI or whether you’d rather save that money to cover your loan’s closing costs or pay for other expenses.
PMI doesn’t last forever
Another piece of good news regarding PMI is that it doesn’t last forever.
Once you build equity in your home of at least 22%, your mortgage lender is required to drop your PMI payments automatically. Equity is the difference between what you owe on your mortgage and how much your home is worth. Once you hit that 22% equity level, you don’t have to do anything: Your lender will simply drop PMI and send you a notice of the resulting change in your mortgage payment.
You can also request that your lender drop PMI after you’ve built up 20% equity in your home. If you request this, your lender will usually order an appraisal to determine the current value of your home.
Writte by Don Amalfitano