Understanding PMI: The Basics of Private Mortgage Insurance

Buying a house is a big deal and most of the time, it's a very expensive one! To cope with this, a lot of home buyers borrow money to buy a house. However, if you cannot get 20% down of what the home is priced at then the lender will often require you to have PMI which is also known as Private Mortgage Insurance. So what exactly is PMI? Can you avoid paying it? What are my options? Let's break down what PMI is, why it is required, and how it can change your mortgage journey.

What is PMI?

PMI is a type of insurance designed to protect the lender in case you default on your mortgage. Unlike most insurance policies that benefit the policyholder, PMI primarily safeguards the lender's investment. This insurance is typically required if your down payment is less than 20% of the home's purchase price.

Why is PMI Necessary?

Lenders view lower down payments as riskier. Requiring PMI is a way for lenders to hedge potential losses if a borrower goes belly up. In short, PMI protects lenders themselves, as it reduces the risk that they are taking and allows them to give loans to more borrowers, even high-risk borrowers who cannot afford a big down payment. Generally, PMI costs depend on the size of your down payment, loan type, and credit score. Typically, PMI rates vary from 0.3% to 1.5% of the original loan amount per year.

How is PMI Paid?

There are several ways to pay PMI:

1. Monthly Premiums: Most common, added to your monthly mortgage payment.
2. Upfront Premium: Paid as a lump sum at closing.
3. Combination: Some lenders offer a mix of upfront and monthly payments.

How to Avoid or Eliminate PMI

While PMI is a necessary evil for some, there are ways to avoid or eventually eliminate it:

1. 20% Down Payment: The most straightforward method is to make a 20% down payment.
2. Piggyback Loan: A second mortgage can help you avoid PMI, although it comes with its own risks and costs.
3. Refinancing: Once you’ve built enough equity (typically 20% of the home’s value), you can refinance your mortgage to eliminate PMI.
4. Reappraisal: If your home's value has increased, a reappraisal might show you have 20% equity, allowing you to cancel PMI.

Why Understanding PMI is Important

Private Mortgage Insurance (PMI) is an essential concept for all those people who are planning to enter the world of the housing market. Although you might think it is just another cost, it is an important step to having your Home Loan approved. Be strategic and do what you can to mitigate PMI. You can make your way to homeownership so much easier if you take steps to manage PMI well.