PMI is a common term used when you go for home purchasing. So, what is personal mortgage insurance or PMI? Well, the answer is personal mortgage insurance is a form of insurance that protects home loan lenders such as, a bank, if the borrower defaults in the repayment. This is required by all lenders if you’ve less than 20% equity in your property. The PMI will help you to obtain a mortgage with lower down payment since the lender will be protected against any default on the loan.
Rates and term of PMI
Personal mortgage insurance rates vary depending on the size of the down payment and the loan. Generally, the personal mortgage insurance costs around 0.5-1% of the entire loan amount annually till the equity in the property reaches 20%. Since, you’ll be paying for the PMI for about 3-5 years, you’ll end up paying thousands of dollars. Currently, PMI premiums can be as high as $1,500 per year for a mortgage on a property of $200,000.
Why to avoid personal mortgage insurance
1. High cost: Although PMI cost around 0.5-1% of the entire loan amount, but you end up spending thousands of dollars. Let’s find out how. The average price of a house is around $240,000, which means you’ll have to pay a whooping amount of $200 per month.
2. May not be tax deductible: Although PMI contracts are tax-deductible, but the strange pre-requisite is the married taxpayer should earn less than $110,000 per annum. So, most dual-income families who have a combined earning of more than $110,000 per year have to bear the tax-sting.
3. Give away money: Homebuyers who pay less than 20% of the sale price of the house, have to pay mortgage insurance till the equity reaches 20% of the house. This could take a long time and you’ll end up spending thousands of dollars only to pay the PMI.
4. Difficult to cancel: Though it is said that you can cancel the PMI as soon as you reach 20% in the equity, but it takes several months to carry out the process. Many lenders require a letter from the homeowner requesting to cancel the PMI as well as receive a formal appraisal of the home prior to its cancellation.
5. Payment continuation: Some lenders want their borrowers to pay the PMI for a fixed period of time. So, even if you’ve met the 20% equity, you might have to continue paying for the specific period of time. You’ll end-up paying much more than required in such cases.
How to avoid personal mortgage insurance
You can avoid personal mortgage insurance even if you don’t have the 20% down payment for the property. Let’s check out the ways by which you can avoid PMI –
1. Piggyback or 80-20 loans: In this method, you have to take 2 mortgages. The first loan will worth 80% of your home’s value and the second mortgage will be for the remaining 20%. Since your first mortgage will meet the 80% rule of the PMI, you won’t have to pay any personal insurance.
2. 80/15/5 loans: Many lenders offer this loan to the borrowers where the borrower will have to pay only 5% toward down payment. This plan in the same way as the ‘piggyback’ plan.
3. Lender-paid PMI: In this plan, the PMI is paid by the lender. But to qualify for a lender-paid PMI plan, you must have a very good credit rating and excellent qualifications.
While personal mortgage insurance is helping those who have limited resources to own a house, but be very careful while taking the PMI. Unless you’re sure that you can attain 20% equity of your property in a couple of years, it makes sense to take a piggyback loan or make a larger down payment.