Many first-time homebuyers are shocked by the amount of additional costs involved in purchasing a house. Inspections, insurance, closing costs, fees, and taxes can quickly add thousands to the price of the home.
If you're not paying at least 20 percent down, you'll likely have the additional expense of private mortgage insurance (PMI). Our attorneys explore this unique form of insurance and offer tips for homebuyers to reduce or eliminate PMI quickly.
What Buyers Need to Know About Private Mortgage Insurance
Lenders require homebuyers to purchase PMI when their down payments are less than 20 percent of the value of the home. The evaluation of PMI is usually between .03 percent and 1.5 percent, based on the appraised value of the home, your credit score, and the amount of the down payment.
The good news is that PMI is only required until you have gained a certain amount of equity in your home. The bad news is that PMI is an extra expense that does nothing to protect you from foreclosure.
Unlike other forms of insurance you buy, PMI doesn't protect you—it protects your bank and lender if you become unable to pay the mortgage. If you had a low down payment on a conventional loan and default on the loan after just a few years, the bank will likely lose money when it repossesses and re-sells your house.
However, buyers who put down 20 percent or more own a significant portion of the property before they've even moved in, making them less of a credit risk.
Before purchasing PMI, homebuyers should ask lenders about:
- Payment options. The most common way to pay for PMI is by adding the premium to your monthly mortgage payment, but some lenders offer a one-time lump-sum premium paid at closing. Your lender may also offer a combination of both.
- Automatic removal. Lenders are usually required to remove PMI automatically from the mortgage payment once the buyer has paid the loan balance down to 78 percent of the initial value. However, you may want to double-check the lender’s policy and establish the earliest possible time you qualify to have PMI removed. In most cases, buyers can request that PMI is removed when they have paid 80 percent of the home’s value.
- Other options. Borrowers making a low down payment may have other options besides a conventional home loan. Many lenders offer specialized loans, such as an FHA or one tailored for purchasing property in an underdeveloped area. If you qualify for these alternatives, it's worth crunching the numbers to see how these types of loans compare to a conventional loan with PMI. A loan without PMI at a higher interest rate may not save you much money over a conventional option.
It Pays to Get Rid of PMI As Soon As Possible
The only benefit homeowners get from PMI is the ability to secure a loan to buy the house. Since you'll be paying for something every month that doesn’t help you at all, you should keep a close eye on your mortgage balance and have PMI removed as soon as you can.
For example, let's say the appraised value/purchase price of your home is $300,000. You put five percent down, or $15,000, and the bank issues you a loan for $285,000. You make mortgage and interest payments every month, plus the additional amount for PMI. When your mortgage balance reaches $234,000, you've reached the 78 percent value threshold, and the lender will drop the PMI automatically.
On the other hand, you could call or write your bank when your mortgage balance reaches $240,000, or 80 percent of the home’s value, and request removal of the PMI. It may not seem like two percent makes much of a difference, but in this case it means you could save hundreds in PMI premiums.
Buying a home is one of the biggest financial transactions you will make, and a Florida real estate attorney can protect you both legally and financially throughout the process. If you have questions about buying or selling real estate, please fill out our quick our contact form so you can move forward with peace of mind.