When buying a home, lenders typically like to receive at least 20% down. While it is possible to purchase a property with a lower down payment, it comes at a higher cost because the lender will require the homebuyer to pay private mortgage insurance, or PMI. This article explains what PMI is, how it may affect you as a homebuyer, and possible ways to avoid having to pay it.
What is private mortgage insurance?
Private mortgage insurance is a type of insurance banks or lenders charge homebuyers who receive a conventional loan in which they put less than 20% down. PMI may also be charged if there is less than 20% of the equity in the home when refinancing. This insurance protects the lender in the event the homeowner defaults or stops paying the mortgage.
Your PMI payment is an additional fee that is charged on top of your monthly principal and interest payment for your mortgage, property insurance, and taxes. The monthly payment for PMI ends on a predetermined date provided by your lender when the loan was originated, or when your principal balance is below 78% of its original appraised value.
How much does it cost?
PMI can cost anywhere from 0.41% to 2.25% and is largely determined by your credit score, loan-to-value (LTV) ratio, and debt-to-income (DTI) ratio. Most commonly PMI is charged to the homebuyer in the form of a monthly payment, although some banks may charge PMI as a one-time up-front payment as a part of the loan, or a mixture of both.
If you want to purchase a $300,000 home but only have 10%, or $30,000, to put down, the bank would charge you PMI. If you receive a reasonable rate of 1% PMI, you would be paying $225 extra per month for private mortgage insurance. You would pay $16,527 in PMI alone over the period of time it takes you to reach 20% in equity. At that point, the additional PMI charge is canceled.