If you qualify for conventional financing, but you put less than 20% down on the home, you’ll pay Private Mortgage Insurance. It’s a cost that has many would-be-buyers shuddering and it makes some avoid taking out the loan altogether.
Is PMI as bad as people make it seem? It has its good and bad sides – keep reading to see how it may affect you.
The Benefits of Private Mortgage Insurance
PMI is an extra charge every month, but there are certain benefits that it does allow:
- You don’t need a large down payment – You can get a loan with as little as 5% down in some cases. Of course, you have to qualify with your credit score and debt ratio to prove that you can afford the loan, but if you qualify, the PMI helps you. The PMI helps lenders know that they will still receive most of the money that you borrowed even if you default. That extra charge every month gives you the boost you need for approval.
- You can buy a home sooner – Without the need to save for a 20% down payment, you can likely become a homeowner much sooner than if you needed 20% down on the home. Let’s say you wanted to buy a $200,000 home, a 20% down payment would be $40,000. If you only needed a 5% down payment, you’d only need a down payment of $10,000. Chances are that it is a lot easier to save $10,000 than $40,000.
- You can request lender paid PMI – If you don’t want the extra charge on your mortgage payment each month, you can ask for lender paid PMI. The lender will pay the total cost of the loan’s PMI upfront for you. In exchange, they charge you a slightly higher interest rate. If the extra interest charges are less than what the PMI would cost, it may make sense for you to do so.
- You can cancel PMI – You don’t have to pay PMI forever, unlike FHA and USDA loans. You can request cancellation of the insurance once you owe less than 80% of the home’s value. You have to request the cancellation, which means keeping tracking of your home’s appreciation and your outstanding principal balance. You can request cancellation in writing. If you don’t cancel at that point, the lender must cancel it automatically once you owe less than 78% of the home’s original value.
The Downsides of Private Mortgage Insurance
There are downsides of PMI that you should know about just to make sure it’s right for you:
- PMI raises your debt-to-income ratio – You pay PMI on a monthly basis, which means it makes your mortgage payment higher. This makes your housing ratio and total debt ratio higher. Conventional loans allow a 28% housing ratio and 36% total debt ratio. If you are near that before the PMI, the Private Mortgage Insurance may set you over the limit.
- You can’t count on your home appreciating – The housing crisis taught us that home values could drop fast. If you count on canceling the PMI in a few short years, yet your home’s value drops, you won’t be able to cancel it.
- It’s an added expense – If you look at the big picture, Private Mortgage Insurance can cost you thousands of dollars on top of the actual cost of the home. Even if PMI costs you an extra $50 a month and you pay it for 10 years, that’s an extra $6,000 that you won’t see again. You don’t get reimbursed for the insurance premiums that you pay.
- The insurance is for the lender – Even though you pay the premiums for the insurance, it protects the lender. If something happens to your home or you can’t make the payments, it’s the lender that has coverage, not you. The only coverage you have is your homeowner’s insurance, which covers you in the event of a disaster that occurs to physically harm the home.
Private Mortgage Insurance has good and bad sides. Generally, it helps buyers afford the home that they want/need. Before you accept PMI, make sure you explore all of your options. Ask about the actual cost of the PMI as well. Each buyer pays a different amount as it’s based on your LTV and credit score.