Buying a house is one of the biggest investments you will make in your life. When you buy your dream home with a mortgage from a bank, the bank wants to make sure that its investment - the mortgage loan it grants you - is well protected from the danger of foreclosure. PMI, or private mortgage insurance, alleviates some of this risk to lenders.
What is PMI?
Foreclosures are long and ugly processes, both for the lender and the borrower. PMI, or private mortgage insurance, is a type of insurance required by mortgage lenders and banks to help mitigate the risk of foreclosure by the property owner and mortgagee. Just to be clear, if you’re paying PMI, you are paying for insurance that protects the bank in the event that they need to foreclose. When a property is foreclosed by the bank or lender, the legal process of foreclosure incurs fees that the lender or bank must pay, especially in the event of contested litigation. According to Ron Weiss, contested foreclosures are even more time-consuming and labor intensive for the lenders. Once the bank has foreclosed on the property, they must then dispose of the property through selling it to recoup any legal costs or even just to break even.
Why Do I Have to Pay PMI?
Mortgage lenders require PMI when the person purchasing the home and obtaining the mortgage loan has anything less than a 20% down payment on the purchase price of the home. The amount of PMI that you pay will be based upon the amount of your down payment; even if you cannot make a 20% down payment, making a significant down payment of 10% or 15% will reduce the PMI your lender requires. PMI payments are rolled into the monthly payment of your mortgage. There are some loan products that do not require PMI, such as VA (Veteran's Affairs) backed loans; however, conventional mortgages will require PMI if you are below the 80/20 loan to down payment ratio.
When Do I Stop Paying PMI?
You can expect your PMI payments to stop when your principal balance owed on the mortgage goes lower than 80% of the home’s appraised value. Using online calculators with amortization tables can help you pinpoint that date by inputting the start date of the loan, the interest rate, and your initial down payment. One other important means of ending your PMI payments is to have your home appraised by paying for the services of a professional appraiser, and you will typically need to refi. If your equity rises above 22%, your lender is supposed to terminate PMI automatically for most loans.
If your home is in a real estate market where home values have increased in a short span of time, or if you have invested in home improvements which add base value to your home, your home may appraise higher than your purchase price and you may now meet the 80/20 loan to principal threshold and can contact your mortgage lender for steps on how to remove the PMI.
As you search for your next home, be sure to calculate the overall impact of PMI on your total monthly payment. We have experts here at Alliance to walk you through any headaches when you're ready.