In most cases, insurance is a good thing. Health insurance curtails medical costs, and car insurance helps cover repairs after an accident. You would think private mortgage insurance (PMI) is just as beneficial as the other insurance you have. Unfortunately, that’s not necessarily the case: someone is protected by the PMI you pay for, and it isn’t you.
What is PMI?
Private mortgage insurance protects lenders in case borrowers default on their mortgage. Most lenders require that buyers make a 20% down payment on a house. With that in mind, consider the average price of a home in America is around $200,000. You’d need about $40,000 to cover a 20% down payment on a house. What happens when you can’t pay that much?
In that case, you may still be able to get a mortgage. However, you’ll be saddled with a monthly mortgage insurance premium in addition to your regular house payments. The PMI cost is dependent on the cost of the home and the buyer’s credit score. The annual cost is usually between 0.25% and 1% of the loan, but can go up to 2%. Once you’ve paid off 20% of the total equity of your home, you can request to end your extra PMI payment.
Why is PMI Bad?
At first glance, private mortgage insurance seems advantageous. It allows people to buy homes in spite of the inability to make a big down payment. Yet the buyer gains nothing from making this additional monthly payment; the PMI payments are an extra couple hundred dollars a month that could go into savings or investments. As stated previously, PMI is one of the few insurance policies that doesn’t help the person paying for it. The buyer is stuck protecting the lender in case of default on a mortgage, and sometimes the lender requires a buyer to pay PMI for a certain amount of years—even if 20% has been paid off the total equity.
How to Avoid PMI
The easiest way to avoid being forced to have private mortgage insurance is to make a 20% down payment on your home! But if life were that simple, no one would need to have PMI in the first place. There are some realistic ways to get around this unnecessary expense. Some lenders allow you to pay your year’s worth of PMI up front. While coming up with the money may be difficult, it’ll save you the trouble of coming up with the cash down the line.
Others may give the option of LMI, lenders mortgage insurance, which is technically a form of PMI. Instead of having an extra payment every month, buyers with LMI have a higher interest rate on their mortgage. They may have some breathing room at the end of the month, but end up accumulating more interest, thus making mortgage payments for a longer period of time.
Perhaps the most common way to avoid PMI is to take out a piggyback mortgage. When a buyer piggybacks, he takes out a second, smaller loan to supplement his down payment. For example, you have enough to make a 10% down payment on a home. To avoid PMI, you take out a small loan to cover the remaining 10% of a 20% down payment.