Thanks to PMI, you don’t need 20% down
For many home buyers, one of the biggest challenges to enjoying homeownership is the downpayment.
Thanks to private mortgage insurance, or PMI, U.S. home buyers have a number of low, or even no downpayment options available to them.
Home buyers often try to avoid PMI because they think it’s “bad.” But consider this: PMI allows buyers to own a home much sooner, capitalize on home appreciation, and avoid rising rents.
Sure, home buyers can wait to save up 20%, or exhaust their savings, but PMI could be a much better alternative.
Private mortgage insurance is nothing to be afraid of. It’s simply an insurance policy issued by a private company that lowers risk for the lender.
In turn, lenders can approve a mortgage at well below the 20% down mark. Thanks to PMI, buyers can own a home sooner.
Choosing between 4 types of PMI
Mortgage insurance typically reduces the upfront cost of the home and spreads it out via slightly higher monthly payments. The type of mortgage insurance will determine the length of time for which the homeowner will make the higher payment.
The four types of mortgage insurance does not include those offered with government-backed loans such as FHA MIP, or “mortgage insurance premium.” Rather, these are private mortgage insurance types which are issued with conventional loans, and they come in four varieties:
- Borrower-paid (BPMI)
- Lender-paid (LPMI)
- Single premium
- Split premium
Each type comes with its own advantages that suit various situations. Choosing the right one can put you in an ideal home buying position.
1. Borrower-paid monthly PMI
Borrower-paid monthly mortgage insurance (BPMI) is the most common type and is often known simply as “PMI.” It is the “default” type of PMI, and the payment is tacked onto the regular mortgage payment.
BPMI can be canceled. You pay it until your loan principal drops to 78% of the home’s value. In other words, it drops off when you reach 22% equity in your home.
This percentage is based on the lesser of the original purchase price or current appraised value.
BPMI might be the right choice for a buyer who is unsure how long they will stay in the home or keep the mortgage. There is no upfront cost to this type of PMI, and no waiting period to cancel it via a refinance or lump-sum payment to your principal loan balance.
2. Lender-paid PMI (LPMI)
With LPMI, the lender “pays” your mortgage insurance for you. But they don’t do it for free. Instead, they raise your mortgage rate. A higher rate enables the lender to cover the cost of a lump-sum buyout of your mortgage insurance.
Home buyers who choose lender-paid mortgage insurance might have a lower mortgage payment than if they paid PMI monthly. Having a lower monthly mortgage payment could mean qualifying for more home.
It’s important to note however, that LPMI cannot be canceled. The mortgage insurance is built into the interest rate, and the rate does not go down when the homeowner reaches 22% equity.
So, LPMI might be a good solution for a home buyer planning to stay in the home or keeping the mortgage for five to ten years. It typically takes 11 years to build enough equity to cancel a borrower-paid mortgage insurance policy.
3. Single premium PMI
Single premium PMI allows the homeowner pay the mortgage insurance premium upfront in one lump sum, eliminating the need for a monthly PMI payment.
It’s somewhat like lender-paid mortgage insurance in that there’s a buyout of PMI in the beginning. But instead of receiving the higher rate like with LPMI, the home buyer pays for the buyout in cash, or by financing it into the loan amount.
Single premium PMI results in a lower monthly payment compared to paying PMI monthly, which helps the buyer qualify for more home.
The risk, however, is that you will only keep the mortgage or home for a few years. The single premium is non-refundable.
If rates drop and you refinance in a few years, for instance, you lose that upfront payment, or have a higher loan amount because of it.
4. Split premium PMI
Probably the least common type of private mortgage insurance is split premium mortgage insurance. While uncommon, it is a good option, allowing the homeowner to pay a portion of the insurance in a lump sum at closing.
The remaining amount is then paid in monthly installments. The home buyer gets a sharp discount on their monthly PMI since a portion was paid upfront.
For instance, a home buyer purchases a home for $250,000. He pays 1.0% upfront ($2,500) to the mortgage insurance company. His monthly mortgage insurance drops to $83 per month, from $123. In this case, it would take five years to make back the upfront payment. Split premium PMI might prove useful to someone who has extra cash, but is above the typical 43 percent debt-to-income ratio maximum.
Making a partial upfront payment could help them bring down their monthly payment enough to qualify.
How much does PMI cost?
The costs of PMI can vary from one lender to the next, but is typically based on the costs passed along from the actual insurance companies.
The amount paid for mortgage insurance premiums are based on the following:
- Loan amount
- Terms of the loan
- Loan-to-value ratio
- Type of loan
- Credit score
PMI premiums can range from 0.2% to over 1% of the loan amount per year, paid in monthly installments.
As an example, a $200,000 loan amount at an annual premium of 0.5% would cost $83 per month.
PMI payments are heavily based on credit score. For instance, a buyer with a 640 score will pay more than $300 per month with a 5% down loan at an average home price. The same borrower with a 740 score would pay just over $100 per month.
Home buyers with lower credit scores should consider an FHA loan. Mortgage insurance for FHA loans does not rise due to credit score.
Which kind of PMI is best?
Because there are substantial benefits to each type of mortgage insurance, home buyers should consider the different options and how they relate to their current situation and long-term goals.
Generally, home buyers who plan to stay in the home and don’t plan to refinance might consider buying out their mortgage insurance via LPMI or a borrower-paid single premium.
However, it’s very difficult to predict the future. The PMI policy that comes with the lowest risk is the standard borrower-paid variety in which you pay a premium each month with your payment.
Most home buyers keep their mortgages less than 7 years, at which point they sell or refinance. And, as home values rise, many buyers refinance out of PMI after just a few years.
Think long-term when considering your mortgage insurance options.
What are today’s rates?
Current mortgage rates are low and it’s an ideal time to buy a home, no matter which type of PMI you choose.
Get a quote for your home mortgage. Quotes are easy to get, take just minutes, and don’t require a social security number to start.