What is PMI? How does PMI work?
Private mortgage insurance (PMI) protects the lender if you stop making payments on your loan. Lenders may require you to purchase PMI if your down payment is less than 20 percent of the sales price or the appraised value of the home. PMI premiums are added to your monthly mortgage payment. You may be able to cancel private mortgage insurance after a few years based on certain criteria, such as paying down your loan balance to a certain amount.
TIP: If you are making a down payment of less than 20 percent, be sure you know if PMI is required and how much the PMI will add to your monthly payments. Not making on-time payments may delay when you can cancel your PMI. Before you commit to paying for mortgage insurance, find out the specific requirements for cancellation.
TIP: Don’t confuse PMI with mortgage life insurance, which is designed to pay off a mortgage in the event of a borrower’s death or disability.
Contributor, Consumer Financial Protection Bureau
6 Reasons To Avoid Private Mortgage Insurance
If you’re thinking of buying a home, remember you’re going to need to save up enough money for a 20% down payment. If you can’t, it’s a safe bet that your lender will force you to secure private mortgage insurance (PMI) prior to signing off on the loan. The purpose of the insurance is to protect the mortgage company if you default on the note.
Private mortgage insurance sounds like a great way to buy a house without having to save up the cash for a down payment. Sometimes it is the only, or even the best, option for new homebuyers. However, there are several reasons would-be homeowners should try to avoid paying this insurance. In this article, we’ll examine the six common problems with PMI and then explore a possible solution that allows homebuyers to avoid it altogether.
Six Good Reasons to Avoid PMI
1.Cost – Private mortgage insurance typically costs between 0.5% to 1% of the entire loan amount on an annual basis. On a $100,000 loan this means the homeowner could be paying as much as $1,000 a year, or $83.33 per month – assuming a 1% PMI fee. (Calculated as: $100,000 x 1% = $1,000 / 12 = $83.33) By itself that’s a pretty hefty sum. However, the average home price, according to the National Association of Realtors is about $230,000, which means families could be spending nearly $200 a month on the insurance. That’s as much as a car payment!
2.May Not Be Deductible – Private mortgage insurance contracts are tax deductible – that is, if the married taxpayer earns less than $110,000 per year (in adjusted gross income). For married couples filing separately, that threshold is $55,000. This means many dual-income families with a combined income just above the threshold will be left out in the cold. While there are rumors this “income cap” could be raised in the future, there is no guarantee it will happen. Many homeowners (particularly those just above the threshold) may be better off making a larger down payment where at least they’ll have the peace of mind that the interest on the loan is be deductible. For more on this important deduction, read The Mortgage Interest Tax Deduction.
3.Your Heirs Get Nothing – Most homeowners hear the word “insurance” and assume that their spouse or their kids will receive some sort of monetary compensation if they die. This is simply not true. The lending institution is the sole beneficiary of any such policy, and the proceeds are paid directly to lender (not indirectly to the heirs first). If you want to protect your heirs and provide them with money for living expenses upon your death, you’ll need to obtain a separate insurance policy. Don’t be fooled into thinking PMI will help anyone but your mortgage lender.
4.Giving Money Away – Homebuyers who put down less than 20% of the sale price will have to pay mortgage insurance until the total equity of the home reaches 20%. This could take years, and it amounts to a lot of money the homeowner is literally giving away. To put the cost into better perspective, if a couple who own a $250,000 home were to instead take the $208 per month they were spending on PMI and invest it in a mutual fund that earned an 8% annual compounded rate of return, that money would grow to $37,707 (assuming no taxes were taken out) within 10 years.
5.Hard To Cancel – As mentioned above, usually when a homeowner’s equity tops 20%, he or she no longer has to pay PMI. However, eliminating the monthly burden isn’t as easy as just not sending in the payment. Many lenders require the homeowner to draft a letter requesting that the PMI be canceled, as well as receive a formal appraisal of the home prior to its cancellation. All in all, this could take several months depending upon the lender.
6.Payment Goes On and On – One final issue that deserves mentioning is that some lenders require the homeowner to maintain a PMI contract for a designated period of time. So, even if the homeowner has met the 20% threshold, he or she may still be obligated to keep paying for the mortgage insurance. Check with your lender and read the fine print of a PMI contract for more specifics.
It’s Not All Bad For many Americans PMI is deductible.Those families who itemize their deductions and earn less than $110,000 per year, will find that their PMI is deductible. For a couple with a $250,000 loan and a $2,500 annual PMI payment (1% of the outstanding loan), this deduction could translate into savings of $300 to $400 dollars or more (depending upon the couple’s tax bracket). Contributor, Glenn Curtis Investopedia