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If you’ve been looking into getting a mortgage, you’ve probably heard the term PMI get floated around quite a bit. You may be unsure of what the term means or how it can have an effect on your bottom line. Read on below to end the confusion once and for all. This post covers what PMI is, how it’s paid, and what you can do to avoid it altogether.
What is PMI?
PMI – also known as private mortgage insurance – is a type of mortgage insurance that you may be required to have if you buy a home with a conventional loan. Though, it might seem strange, this insurance requirement is there to protect the lender, not you. It’s there to shield the lender from a loss if you end up defaulting on the loan.
Federally-backed loans, or FHA loans, also have a similar requirement. In this case, it’s known as your mortgage insurance premium (MPI). However, unlike conventional loans, where you can usually get rid of your mortgage insurance requirement over time, FHA buyers are required to keep up their MPI payments for the entire life of the loan.
How is PMI charged?
The way in which PMI is charged may vary according to the lender. However, usually this premium is included as part of your monthly mortgage payment, meaning that though you’re paying slightly more than you would be without it, you don’t have to worry about writing another check each month.
In other cases, PMI is collected in one lump-sum at settlement, meaning that you’d have the choice between paying in cash-on-hand or rolling the payment into your loan amount. Alternatively, you may experience a mix of both upfront and monthly payments.
When can you stop paying PMI
Most lenders allow you to drop your private mortgage insurance once you’ve built up at least 20% equity in your home and have a loan-to-value ratio of 80%. How long it will take you to get there will depend on things like the size of your monthly mortgage payment, as well as your down payment.
Sometimes lenders will have a few additional stipulations that you must meet in order to get rid of your PMI requirement. For example, you could be required to have a history of making your mortgage payments on time or they may not allow you to drop the requirement if you have a second mortgage.
How can I avoid PMI?
Of course, the easiest way to avoid paying PMI is to have the requirement is to have the requirement waived altogether. You can do this if you’re able to make a large enough down payment – one that covers 20% of the loan and gets you that 80% loan-to-value ratio from the start.
Ultimately, you have to do what makes the most sense for you. While avoiding PMI may be feasible for some, for others, accepting the PMI requirement is simply a necessary part of becoming a homeowner. It’s up to you to balance your financial capabilities with the realities of your local market in order to make the decision that works best for you.