Private Mortgage Insurance Can Help Make Your Dreams of Homeownership Come True
Private mortgage insurance, also known as PMI, is an additional fee lenders may require for borrowers who have a low down payment, which is usually defined as less than 20 percent of the sale price.
At first blush, you may think private mortgage insurance sounds like just another fee you'll have to pay in the home buying process. However, in reality, PMI may save you money and make your dream of homeownership a reality.
To get an idea of how private mortgage insurance can help potential homeowners, consider this example:
If you need a mortgage of $130,000, but you only have enough for a three percent down payment ($3,900), the lender will probably require you to pay PMI. PMI can vary depending on the loan amount and the lender, but typically it's around one percent of the loan. This would equal approximately $1,300 annually and must be divided by 12 for a monthly amount that will be added to your principal and interest payment. Then $108.33 would be added to your monthly mortgage payment and would last approximately 10 years before the loan-to-value is less than 80 percent.
So, if you calculate ($108.33 * 12 months)*(10 years) = $13,000; $3,900 down payment + $13,000 = $16,900; generally there is limited cost savings, if any. However, PMI will get you into the home sooner than waiting to accumulate $26,000 (20% down payment).
Why lenders require private mortgage insurance
In the above example and similar cases, you can see how this helps you save money and still buy a home. But how does it help lenders? Lenders require private mortgage insurance to protect them against default on the mortgage loan. To a lender, a borrower with a low down payment represents an increased amount of risk. If you don't have the full amount of money required at your disposal now, there's a greater chance you'll also be low on cash down the line. Without PMI, this may cause the lender to decline your loan application. But, if you agree to pay this extra insurance, the lender will be able to issue the loan.
How private mortgage insurance is paid
PMI payments can be included with your monthly mortgage payment, home insurance coverage and taxes. You'll continue to pay it until the principal of the loan is paid down to 80 percent of the home's value. If you were considered a particularly high-risk borrower, you may need to pay PMI until the loan is worth less than 80 percent, so ask your lender.
Protect your investment with home owner insurance
Lenders will require you to have both PMI and home owner insurance. Once you own your home, be sure to protect it with adequate home owner insurance. Home insurance coverage can help you with necessary repairs in the event of damage or theft and is also required by law. If the unfortunate ever occurs, you'll be glad you have it.
While a home inspector may miss certain problems during the inspection, a homeowners warranty lets buyer and seller know that problems in the home related to the warranty will be taken care of.
Think your credit score affects only your ability to borrow money? Think again. Your credit score also can affect your access to homeowner and car insurance and the size of your monthly premiums.