5 Things you need to know
The first time you buy a home, you're sure to learn a lot about the mortgage process. You can read all you want about mortgages beforehand, but something unfamiliar always seems to pop up! One thing that surprises a lot of buyers is the need for private mortgage insurance or PMI. Here are five key things you should know about PMI as a potential home buyer.
1. PMI Is Required for Smaller Down Payments
Have you ever wondered why some of your friends were able to buy a home without paying for PMI? Chances are, those friends made larger down payments when they purchased their homes. Generally, you are required to have PMI if you make a down payment of less than 20%. Many banks are happy to give you a mortgage with a 10% down payment, or sometimes even less, but the stipulation is that you then pay for PMI. If you really want to avoid paying for PMI, the only way to do so is to save a larger down payment.
2. PMI Protects the Lender, Not You
You're probably used to paying for insurance to protect yourself and your interests. This is true of homeowners insurance, auto insurance, and also health insurance. But PMI is different. This insurance protects the bank or other institution that lends you money to buy your home. If you default on your mortgage, the private mortgage insurance company will reimburse your lender for the funds you do not pay. PMI makes it safer for lenders to approve mortgages for borrowers who can't afford or don't want to make a 20% down payment.
3. PMI Is Generally Paid Along With Your Mortgage
Generally, your PMI payment is added to your monthly mortgage payment. Your mortgage company will hold the money in escrow and use it to pay your PMI premium when it becomes due. Say, for example, you have a monthly mortgage payment of $500, and an additional monthly PMI payment of $100. You'll end up paying $600 a month to your mortgage company, and they'll take care of the rest. You won't have to worry about scheduling an extra payment each month.
4. PMI Is Usually About 1% of the Purchase Price
If you're beginning to shop for homes and mortgages, of course, you'll want to know how much to budget for PMI. Costs do vary between companies and lenders. However, you can generally expect to pay about 1% of the loan amount, per year. For example, if you take out a $100,000 mortgage, you can expect to pay about $1,000 a year for PMI. This will be divided into 12 monthly payments to your mortgage company, meaning you'll pay about $83 a month on top of your monthly mortgage payment.
5. PMI Continues Until You Refinance
There's a common misconception that once you reach 20% equity in your home, PMI will drop off. This is not the case. If you do reach 20% equity in your home, then you can refinance and drop PMI in the process. Most homeowners wait until mortgage rates come down or they have another reason to refinance. Then, they take out a new mortgage with a lower down payment, so they no longer have to pay for PMI.
Private mortgage insurance protects the lender and makes lenders more willing to issue mortgages to those who can't make a big down payment. Now that you know more about it, there should be fewer surprises as you shop for a home and take out a mortgage.