The Financial Implications Of Private Mortgage Insurance
Private Mortgage Insurance, more commonly referred to as PMI, is a mortgage expense that draws a wildly varying set of opinions from homebuyers and homeowners. Before we dive too deep into the financial implications or pros and cons of PMI, you need to fully understand its background, what it is and why it exists.
First, PMI is not a new concept. It was originally introduced more than 120 years ago as a tool to protect banks so that they can provide mortgage financing to those that lacked the assets to provide a substantial down payment.
To this day, it still serves the exact same purpose. How it is used, how much it costs and who has to pay it has taken many forms since the idea was first introduced. I will spare you the history lessons – Wikipedia has that covered – although it does provide insight into why different generations vary from ambivalence to disgust when it comes to the subject.
Simply put, PMI allows borrowers to obtain a mortgage without having to provide 20% down payment by covering the lender for the added risk of a high loan-to-value (LTV) mortgage. It has helped MILLIONS achieve home ownership. It is not the devil. It’s a financial decision made daily by families everywhere. Let’s get the skinny, shall we?
PMI is risk-based. Your credit score and debt-to-income ratio will play a part in your premium. They are both secondary players to the lead character: loan-to-value. If you need OR choose to put the minimum down, then you’ll pay more. So 5% down borrowers will pay more than 10% down borrowers and 10% down borrowers pay more than 15% down borrowers.
So that is your first decision: what do I have in the bank, how much of it should I use and what will it set me back if I decide not to put it all into a house?
You have another decision though. There’s more than one kind of PMI. Traditional mortgage insurance is “Borrower Paid Monthly.” It’s added to the top of each and every mortgage payment for a minimum of two years. There’s also “Single Premium MI” which is exactly what it sounds like – a single lump sum payment at closing – and “Lender-Paid MI,” which is where the lender pays the mortgage insurance for you by slightly increasing your interest rate.
As you wade through these options, you need to consider a couple of factors: tax bracket and how long you intend to live in the home.
The tax deduction for PMI expired, but the tax deduction for mortgage interest is still in play for most Americans. More interest equals a bigger deduction. The reason you need to consider how long you intend to be in the home is because Lender-Paid MI never drops. Traditional PMI, the kind paid monthly, is potentially removable after two years assuming you have reached 78% loan-to-value or less.
Regardless, poor Private Mortgage Insurance choices can cost you a lot of money – money that you might have saved so you can put 20% down the next time you buy, to avoid the entire PMI dilemma.