Basics of Private Mortgage Insurance (PMI)


Because PMI functions as a type of mortgage insurance, it makes lenders more comfortable giving out larger loans than borrowers would typically be able to get without PMI.Private mortgage insurance (PMI) is a way that lenders protect themselves against the possibility of a borrower not being able to make mortgage payments. Many homeowners and homebuyers are not familiar with the details of PMI and may not even realize they are currently paying it or that there are ways to avoid it.

Because PMI functions as a type of mortgage insurance, it makes lenders more comfortable giving out larger loans than borrowers would typically be able to get without PMI. Borrowers need to keep this in mind so that they do not overextend themselves when they take out a loan that comes with PMI.

Typically, if you make a down payment of less than 20 percent of the home’s price and take out a conventional loan, you will have to pay PMI. If you are refinancing, the lender will typically decide based on whether your equity is sufficient to cover 20 percent of the home’s value.

In certain cases, lenders may offer a conventional loan with a low down payment that doesn’t require you to pay PMI. While this sounds like a great way to save money, it is not always that clear-cut. These loans typically carry a higher interest rate than do ones that either require a higher down payment or include PMI.

“Paying a higher interest rate can be more or less expensive than PMI—it depends on your credit score, your down payment amount, the particular lender, and general market conditions,” according to the Consumer Financial Protection Bureau’s website. “You may also want to ask a tax advisor about whether paying more in interest or paying PMI might affect your taxes differently.”

Some lenders give borrowers only one choice for paying PMI, while others may offer more than one way. So make sure that you talk to your lender to see if you have options. The most common method of paying for PMI is through a monthly premium that is added to your monthly mortgage payment. The fact that it is lumped into the mortgage payment is why many people do not realize they are paying it.

It may also be possible to pay your PMI with a single upfront premium that you pay during closing. It is important to note that you may not be entitled to a refund of the premium in certain instances of moving or refinancing. In other cases, you may pay both an upfront premium and a monthly premium.

One of the most important things to know about PMI is that you don’t have to keep paying it the entire time you have your mortgage. After gaining equity and paying PMI for a certain amount of time, you can contact your lender and ask for it to be removed. Different lenders have different PMI cancellation policies, which is another thing you should consider when comparing financial institutions for a new mortgage. Typically, you need to have paid enough of the principal back to cover 20 percent of the home’s value for the PMI to be removed.

“Another way to avoid the PMI payment is by taking out a smaller loan (typically at a higher interest rate) to cover the amount of the 20 percent down; this is commonly known as ‘piggybacking.’ Now the borrower is committed on two loans, but since the funds from the second loan are used to pay the 20 percent deposit, the borrower can avoid the PMI payment,” states Steven Merkel, CFP, ChFC, for Investopedia.

The good news about this tactic is that it is possible to deduct the interest of both loans if you itemize your deductions on your federal tax return. So, don’t forget to factor these savings in when calculating which option is best.

 

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