A Homebuyer's Essential Guide to PMI

Posted by Shawn Clayton on Friday, February 9th, 2018 at 9:33am.

When Is PMI Necessary?Lenders ideally want to see a 20% down payment from all of their applicants. This gives a new oceanfront homeowner a large share of equity in the home from the moment they move in, which makes them that much less likely to default on the rest of the payments. While 20% may have been reasonable for certain areas in certain time periods, the inflation in many cities today has been high enough that fewer and fewer people can come up with that kind of cash on the spot. Private Mortgage Insurance (PMI) was the solution for these buyers to mitigate the risk a lender takes. See what the rules are before you start shopping around for lenders.

Standard Terms of PMI

PMI is a way to avoid raising interest rates for all potential homeowners. It passes down the financial risks to a private insurer who backs the loan in the case of default. The mortgage policy is secured by the lender but the homeowners are expected to cover the costs of the premium. So essentially, the homeowner pays the lender and the lender pays the insurance company.

PMI costs are typically bundled into a standard mortgage payment until the homeowner reaching 20% equity of their home. Once the homeowner has hit that number, they can discontinue payments for the PMI. Homeowners can deduct PMI on their taxes if their adjusted gross income is less than $109,000 a year.

Money Matters

A lender isn't just taking the insurance policy out for the exact purchase price of the home. They're also accounting for additional fees they'll need to pay if they have to resell the home. Lenders will typically still need to hire real estate agents, arrange auctions, and pay cleaners to get a home ready for resale. So the total cost a homeowner pays for PMI works out to an annual charge of between .5 and 1% of the total purchase price of the home.

So if a home is $100,000, you can expect to pay an additional $500 to $1,000 per year until reaching equity of at least a fifth of the home (or $20,000.) Homeowners who put down higher down payments will enjoy lower percentages on their PMI (plus they'll hit their equity goals earlier.)

Know Your Options, Shop Around

The lender an applicant chooses will have a lot to do with each individual's PMI experience. Some lenders choose insurance companies that make it downright difficult to cancel PMI, meaning a Manasquan homeowner may have to keep paying for PMI until the policy is officially canceled. Other lenders may offer home buyers higher interest rates instead of PMI to offset the possibilities of a default. This is usually more expensive in the long run, but not always.

Finally, some lenders offer homeowners the chance to pay for all PMI costs all at once. If a homeowner has to unexpectedly move shortly after purchase though, they may not get a refund for the unused mortgage premium.

A homeowner is always going to come out ahead if they can put more money into the equity of their home. It's important to start with realistic expectations about your budget before deciding which open houses to attend. While PMI is typically cheaper overall than choosing a different type of loan, there are certain circumstances where this isn't so. A real estate agent or a tax accountant can normally make it easier to choose between the many options for financing a home.

Shawn Clayton, Owner/Broker, REALTORĀ®

Jersey Shores Luxury Home Expert

Contact Shawn

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