If you’re hunting for your first home, it’s likely you’ve heard some mumbling about private mortgage insurance, commonly called PMI. And you’ve probably heard plenty of opinions on whether you should pay it. Some financial experts swear you never should, arguing that it’s just throwing money away, while plenty of other folks think it’s just fine.
The reality is this: While it’s great to put down 20 percent, not everyone can afford to. And even buyers who can afford to do so might not want to, preferring instead to keep a significant cash cushion in the bank.
Whatever your reasons for putting down less than 20 percent, PMI will be a fact of life, so it’s important to understand the facts and whether it makes sense for you.
What is PMI?
Simply put, PMI is insurance that protects the lender when a buyer puts down a reduced amount of money than the standard 20 percent. Think about it like this – if you don’t have a lot of money invested into your home and something happens, what’s to keep you from walking away and leaving the lender in the dust? That’s what PMI protects the lender against. You get to buy your home and the lender has insurance protection in case you default.
Your lender is not required to drop your PMI until the date you’re scheduled to reach 22 percent equity (or 78 percent loan-to-value) – generally between five and seven years after you close, depending on the loan amount and interest rate – though you can refinance out of PMI if you reach 20 percent equity before that date.
How much does PMI cost?
Typically, PMI costs between 0.5 percent and 1 percent of the loan amount each year. So, if you buy a $200,000 house, you could wind up spending $2,000 per year on PMI, or $14,000 over the course of seven years.
Generally, PMI is tacked onto your monthly mortgage payment via the lender. It may be tax deductible depending on your situation. But some lenders – like Alliant – offer lender paid mortgage insurance (LPMI). With LPMI, you can either pay a set
PMI amount up front when you close on your home, or you can pay for it in the form of a higher interest rate. If you take the higher interest rate, that cost is tax deductible as interest paid on a mortgage. Be sure to check out both options to see which one is best for you.
What if I don’t want to pay PMI?
If you are dead set against paying PMI, you have a couple of options. First, you can simply wait it out and not buy a home until you have 20 percent to put down. Or, if you really want to buy now but can’t come up with the 20 percent, you can take out a piggyback loan.
With a piggyback loan, you’re taking out two mortgages: one for 80 percent of the home’s value (called the first mortgage), and another for 10 percent (called the second mortgage). You will still need to come up with 10% of your own funds for the down payment. Once you pay off the second mortgage, you’re left with only the first and no PMI, and all of the interest you pay on both mortgages is tax deductible. You’ll need a good credit score to do this, and the second mortgage will generally have a higher interest rate than the first. If you’re not sure you’ll be able to pay off the second mortgage quickly, this may not be the best option for you.
At the end of the day, it’s important to remember that whether you pay PMI, take out a second mortgage or simply wait until you have 20 percent to put down, feeling financially secure should be top of mind when you’re buying a home. Do what works best for your family – and your wallet – so you’ll be able to enjoy your new home instead of worrying about it draining your bank account.
About Jerrold Anderson
Jerrold Anderson is Vice President, Residential Lending for Alliant Credit Union. one of the largest credit union mortgage originators in the country. Jerrold has spent the last 30 years in mortgage lending helping people get the right mortgage.