While the journey towards homeownership is fun, rewarding, and a major accomplishment, it’s far from easy. Besides the hard work that goes into finding the perfect home, you need to focus on the costs associated with this major purchase.
Taking out a mortgage is the most common way people are able to afford real estate purchases. When the average cost of homes for sale in the United States in 2021 is $313,000, it’s not hard to imagine that buyers need additional financial leverage to afford their new homes.
However, taking out a mortgage isn’t free. Besides paying back their principal, homebuyers need to pay lender fees, property taxes, interest, and mortgage insurance.
What is Private Mortgage Insurance?
Private mortgage insurance, otherwise known as PMI, is an insurance plan that is required by most lenders on traditional loans. When lenders grant a loan, they want to make sure they’re covering their bases and not taking on a loss. Private mortgage insurance protects lenders in case a borrower isn’t able to fulfill their mortgage repayment commitment.
While it may seem like an extra cost, PMI often works in the buyer’s favor.
Mortgage lenders assess each borrower’s application during the underwriting process to decide if they are a good fit for the loan. Lenders look at credit scores, financial histories, and other factors to determine how much of a risk they are willing to take.
When a home buyer isn’t the strongest borrower, the lender adds on a PMI policy to the loan and approves the mortgage. PMI can be leveraged to negotiate the approval of the loan, even for borrowers who aren’t able to meet all of the financial qualifications at the time they buy their home.
So, if you’re making a small down payment or don’t have the best credit score — but are still trying to take out a mortgage to buy your next home — PMI can convince lenders to work with you, despite the odds.
When is PMI Required?
PMI isn’t required on every single mortgage, but it can be expected on most traditional loans with small down payments. So, if you’re going to be working with a bank, a private lender, or an independent financial institution, a PMI policy may be added on.
Most lenders will require a PMI policy if the borrower is placing a down payment on their purchase that’s less than 20%.
However, your lender will always be clear about their PMI requirements before you sign off on your loan. Both the initial Loan Estimate and the Closing Disclosure documents will cover the specific details of your PMI policy, including the cost and how it factors into your complete loan package.
How Much Does PMI Typically Cost?
Like all aspects of a mortgage loan, the answer here is “it depends.”
Mortgages are not cookie-cutter products. They’re personalized, customized, and specially curated to reflect the market conditions, the buyer, and the property it will be funding.
That means PMI doesn’t cost a single flat rate.
Borrowers can expect to pay PMI expenses that are between 0.5% and 1.0% of their annual mortgage amount. The specific rate will be outlined by your lender while your loan is being processed.
PMI is usually paid off throughout the lifetime of the loan, as lenders factor it into the monthly mortgage bill. But in some cases, borrowers are charged PMI-related fees and expenses when they first take out their mortgage. Since the method varies according to the lender, it’s a good idea to ask about how you’ll be paying for your PMI policy.
Can PMI Be Avoided?
Buyers who are using a government program to finance their home purchase don’t need to worry about paying for PMI policies on their home loans. However, traditional lenders are subject to PMI expenses.
Avoid PMI Before the Loan
If you’re using a more traditional source to fund your purchase, you can avoid PMI by making a large enough down payment.
Typically, lenders are looking for anything over 20% of the home’s final purchasing price. Meeting this requirement will help lenders feel confident about letting you borrow money, so they won’t need to add an insurance policy to your loan.
Taking out a personal loan from a close friend or family member can be a way to fund your down payment, helping to avoid PMI costs. Buyers can also take out a smaller private loan outside of their mortgage to pay off their down payment requirements.
Remove PMI After the Loan
Even if you weren’t able to avoid the PMI policy at the initial application and underwriting process, PMI can be removed during the lifecycle of your loan. Once the borrower pays off enough of their loan’s principal amount, they may be eligible to renegotiate their loan terms and effectively remove the PMI policy.
Since PMI is bundled into your monthly payments, removing this additional expense can reduce your monthly costs. Talk to your loan officer to learn how this impacts your mortgage.
Make a Plan For PMI
Homebuyers should take this information into account and make a plan for dealing with PMI.
Whether you’ll dish out the extra cash in the down payment to avoid the larger monthly mortgage bills, or you’ll settle for PMI and negotiate a lower down payment, make the choice that works best for you.
No two home buyers are in the exact same situation, and every mortgage is unique. The best way that buyers can attain success is by learning what they can and applying that knowledge to shape a winning strategy.
Eager to Start House Hunting?
Be sure to carry in these important house hunting lessons regarding your mortgage’s PMI with you as you begin shopping for your dream home. If you’re interested in looking at homes for sale all over the country, see what HomeFinder has to offer today.