How long do I pay? How much do I pay? Can I even get rid of it? When you buy a home with less than 20% down, you must pay for mortgage insurance (PMI). If you are not sure what mortgage insurance is all about, this article will help to make it clear.
Overview of Private Mortgage Insurance (PMI)
To qualify for a mortgage loan that is backed by Fannie Mae or Freddie Mac, you must get PMI with less than 20% down. The PMI is paid monthly by the borrower. It protects the lender against a financial loss if you default. When people put down less than 20% on a home, it is statistically more likely they will default. PMI ensures the lender will get most of their money back if you stop paying.
PMI is required until you have 20% equity in the home. At that point, PMI can be cancelled by requesting it from your lender. But it must be cancelled by law once you have 22% equity.
PMI usually costs you about .5% of the amount of the loan. Thus, if you buy a home for $300,000 and put down 10%, you will pay PMI on $270,000 per year, which amounts of $1350 per year, or $112 per month. This is a considerable additional monthly cost, in addition to loan principal, interest, insurance and taxes.
However, it is not necessarily a bad thing to pay PMI. If you are able to put down 5% on a home rather than 20%, this is a savings of tens of thousands of dollars. Some would say a small price to pay for that is to pay PMI each month. And once you have 20% equity, PMI can be cancelled. The only exception there is if you are not making mortgage payments on time. In that case, you will need to continue paying PMI until you have at least a year of timely payments.
FHA and MIP
Some home buyers get a loan that is backed by the Federal Housing Administration. These loans also require you to have mortgage insurance, but it is called MIP. Mortgage insurance on FHA loans works the same as PMI with conventional loans, but it is a bit more expensive each month. There also is an upfront mortgage insurance fee of 1.75% of the loan amount that can be wrapped into the loan.
A critical issue to know with FHA mortgage insurance is you cannot cancel it in most cases, as of 2018. The US government made MIP mandatory on all FHA-insured loans with less than 10% down in 2013. If you put down 10% or more, you can cancel it after 11 years.
So, once you have reached 20% equity, you are paying for mortgage insurance that you would not be paying for with a conventional loan. If you plan to stay in the home for years more, it is worth considering a refinance into a conventional loan. You will pay for closing costs, but you will be saving that monthly mortgage insurance payment every month for years.
Considerations on PMI
For most people, if you cannot put down 20% without causing major financial woes, it often makes sense to pay PMI. You are going to save yourself a lot of upfront money. Plus, you can stop paying rent years sooner by paying PMI. In many markets that are in strong demand, you will often pay much more in rent than the mortgage payment for the same home. Viewed in this light, paying PMI with your own home could be a wash or even a savings. Also, many people like the idea of owning their own home, even if they pay PMI.
Mortgage insurance premiums also usually help you during tax season. If you are paying PMI, your PMI payments are usually tax deductible. This can save you at least a few hundred dollars on your taxes. Don’t forget to verify your eligibility for a home loan with no PMI.
If you do buy a home with PMI, remember you can cancel it after you have gotten to 20% equity. You will need to send a written request to the lender to ask that it be removed. The lender will review your payment history and respond within a few weeks. If you have been paying on time for a year, they should remove PMI.
However, US law now requires the lender on a conventional loan to remove PMI automatically when you have 22% equity in the home, if you have been making your payments on time. This was done because some lenders were delaying the removal of PMI, probably to increase their financial cover if you were to default. But this is now illegal to do, so you should be able to get rid of PMI once you have at least 20% equity.