Whether you're a
long-time home owner or you've just started shopping for your dream house,
you've seen stacks of papers full of acronyms. Buried amid the dense
undergrowth of legalese are three letters that could be costing you more than
you think. Be on the lookout for PMI: Private Mortgage Insurance.
PMI in a nutshell
Close your eyes and imagine yourself as a venture capitalist, like
those you may have seen on "Shark Tank." An inventor comes to you and
says they've got a killer new product. They need $300,000 now and they'll repay
it with 4% interest over the next 30 years. If they don't, you can take the
manufacturing equipment they're going to buy with your loan, which is worth
about $250,000.
This isn't a great deal for you - the venture capitalist - since
you're putting the remaining $50,000 on the line, and that's not considering
the cost of selling their equipment! They're not risking anything. The
equipment was bought with your money. You need to know they've got something at
stake, too. So, they put up $30,000 of their own money. This is a better deal,
but you've still got more to lose than they do.
This is where an insurance company comes in and says that, for
$3,000 a year, they'll protect the loan. If the inventor fails to deliver,
they'll repay the balance of the loan at that point. Sounds great, but who's
going to pay it? If you do, that just raises the amount you're going to lose on
this deal. Instead, you make the inventor pay it.
That's how PMI works. The home buyer, in this example, is the
inventor, and the lender is the venture capitalist. To make the mortgage an
attractive option for lenders where scenarios like this happen, the home buyer
needs a way to ensure the lender will be made whole (paid back in full) if
something goes wrong. Importantly, PMI is protection for the lender, not the borrower.
If you fail to make your mortgage payments, you will still face foreclosure
even if you're paying for PMI. All that changes is the institution that issued
your loan can recoup its losses.
Who has to pay for it?
Not all mortgages require PMI. In general, loans made where the
principal total is 80% or less of the sale price of the home don't require PMI.
If you put 20% down, lenders see that as a sign that you're a safe risk. You've
got as much skin in the game as they do.
Home buyers with a down payment of less than 20% may have to pay
for PMI. Typically, costs are between 0.5% and 1.0% of the total value of the
loan, with riskier loans requiring higher PMI payments. Sometimes, lenders
offer loans to these home buyers that exclude PMI, but in order to make the
increased risk worthwhile, such loans come with a higher interest rate.
PMI premiums can be made one of two ways. You may notice a line
item in your mortgage estimate or statement that identifies your monthly
premium for PMI. In other cases, it may be included with the closing costs as a
lump sum. Some loans require both a payment at closing and an additional
monthly premium.
When can I stop paying for PMI?
The 20% rule is a helpful one here, too. Once you've paid down
enough of the loan to have 20% equity in your home (meaning your loan amount is
less than 80% of the home's market value), most lenders will no longer require
PMI. Every month, a portion of your mortgage payment goes to paying interest,
and a portion goes to paying the principal. The second part is how you increase
your equity. Think of it as gradually buying your home back from the lender. Of
course, you can make extra payments beyond the mortgage payment to reduce the
principal faster and increase the percentage of home that you own.
Even with a 20% stake in your house, you may have to pay for PMI a
little longer. Policies are generally purchased for a year, and monthly
payments are held in escrow to cover yearly premiums. You may have to continue
paying the premium until the year in which you reach 20% equity ends. Also, if
you happen to live in an area where home values have risen, investigate the
ability to get a new appraisal if you are paying PMI. If your home has gone up
in value enough to get you pas that 20% threshold, you may be able to request
cancellation of the PMI on your loan.
While PMI may seem unfair, remember that without it, lenders would
be less likely to issue mortgages in the first place. PMI helps borrowers
qualify for loans on homes they might not otherwise have been able to purchase.
That means it helps put you in a nicer house without saving more for the down
payment.
SOURCES:
http://www.interest.com/mortgage/news/what-you-need-to-know-about-private-mortgage-insurance/
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