Private mortgage insurance (PMI) is an additional payment required with a mortgage loan that compensates the lender for increased risk.
PMI is generally required on mortgages with a down payment of less than 20%, and usually runs between 0.5% and 1% of the total amount of the loan on an annual basis. For a $200,000 mortgage with less than 20% down, you are likely to pay from $1,000 to $2,000 per year extra.
The payments are typically divided into monthly amounts and integrated into your mortgage payment – in the case above, adding an extra $83.33-$166.67 per month to a mortgage payment that could already be in the $1,000-range depending on the current interest rate. That can make all the difference between smooth sailing and struggling to make your monthly payments.
In the alternative form of PMI known as single premium mortgage insurance (SPMI), you pay the PMI upfront as a lump sum. The PMI costs are dealt with in one of three ways:
- Closing Cost – The SPMI is paid at the time of closing in a lump sum along with the other associated closing costs. This may be a stretch to your budget – after all, the most likely reason that you are paying any form of PMI at all is lack of sufficient money for a down payment upfront.
- Financed – The SPMI is included into the total mortgage amount and is financed and paid off with interest along with the rest of the principal. It does not necessarily count in your loan-to-value (LTV) ratio when you are qualifying for a loan (check with your lender), but it is still a long-term cost to be paid.
- Lender-Paid – The lender pays the SPMI upfront in exchange for a slightly higher interest rate that is applied to the life of the loan. The increased interest rate will result in a slightly higher monthly mortgage payment. However, the increase should not be less when compared to the lower interest rate payment with a traditional PMI payment added.
Why would you want to pay any PMI up front? Generally, the main reason is to keep monthly payments as low as possible. In a seller’s market, this allows a homebuyer to stretch an offer upward, sacrificing longer-term costs while keeping monthly payments manageable. That may or may not be a good idea depending on your overall financial stability – but at least the option is available.
Traditional PMI does have one advantage over financed or lender-paid SPMI – thanks to the Homeowner’s Protection Act, you can have the lender cancel the insurance once you have made enough regular mortgage payments that your risk to the lender is lowered. You can generally make your request once the principal falls to 80% of the original value.
FHA and VA-backed loans have different rules, and there are other potential PMI termination points that apply beyond the 80% mark. Check with your lender to make sure that you understand the PMI terms in any loan before you sign.
If you are preparing to buy a home with limited down money, discuss your PMI options with your lender – including SPMI – and perform a cost-benefit analysis on all of the options available to you. There are many online calculators available to help you run different PMI and mortgage loan scenarios and determine which method is right for you.