It may seem impossible given the surge in the real estate market over the past couple of years, but homes are set to get even more expensive in 2022.
Home values will rise another 11% this year, according to a Zillow Forecast, putting even more pressure on the budgets of future owners. This means that it will become even more important to understand, and potentially reduce, all of the costs associated with buying a home.
One of those costs could be private mortgage insurance. Known as PMI, this is a fee your lender might charge you based on the amount of your down payment. PMI increases your monthly mortgage payments, so before you lock in a loan, you need to make sure you understand what PMI is, how much you’ll be charged, and if it’s worth it.
How much does private mortgage insurance (PMI) cost?
When a borrower has less than 20% for a down payment, in the eyes of the lender, he becomes more at risk of defaulting on the loan. Private mortgage insurance (PMI) aims to protect the lender against this risk.
“It’s insurance that covers the lender’s risk if you can’t afford to put 20% on the property,” says Vicki Idevice president and director of residential loans at Tompkins VIST Bank in Pennsylvania.
Lenders add PMI to your mortgage in exchange for accepting the higher risk of a smaller down payment. The additional fees act as insurance for the lender in the event that you cannot afford to continue making mortgage payments.
The cost of PMI will depend on a few factors, including the amount of the loan and your credit score. Paid monthly or in a lump sum up front, you can typically expect PMI to cost between 0.58% and 1.86% of the loan amount depending Urban Institute mortgage insurance data. In dollars, Freddie Mac Estimates that would look like $30 to $70 per $100,000 added to a monthly mortgage payment.
“If you borrow more, they’re going to charge you more,” says michelle petrowskia certified financial planner in Phoenix.
Here is an example of the breakdown of this cost:
On a $300,000 home with a 30-year fixed rate mortgage:
|5% deposit||20% deposit|
|Amount of the loan||$285,000||$240,000|
|Monthly mortgage payment (principal and interest only)||$1,360||$1,118|
|PMI (0.99% of loan)||$235/month||No PMI required|
|Total cost of ART||$21,983||N / A|
|Total monthly payment*||$1,595||$1,118|
In this example above, the loan with the required 5% PMI down payment. Based on a credit score between 700 and 719, this example borrower can expect to pay 0.99% of their loan amount: $2,821.5. If you divide this figure by 12, you will get the monthly PMI payment of $235. The total cost of the PMI will reach $21,983 when the borrower reaches 20% equity in the home and the PMI payments end.
Remember that the PMI doesn’t last forever: it can be removed once you’ve reached 20% of your home’s equity.
Factors that affect the PMI
The amount of PMI you pay varies by lender, but also depends on your personal financial profile.
But credit score isn’t the only metric that changes the PMI: it also takes into account the amount of the loan, the amount of your down payment and the type of mortgage.
“It’s going to be individualized,” Ide says. Make sure you understand how each of these factors impact the PMI so you can make an informed decision on cost before taking out a mortgage.
Deposit amount :
Your down payment is the key factor that determines whether or not you will pay PMI. If you put 20% or more on the purchase of your home, you will not have to pay PMI. If you deposit less than 20%, however, you can generally expect a PMI.
Ide says the most important thing here is the loan-to-value ratio. For example, if you put 15% on your purchase, that’s an 85-15 ratio (ie 85% mortgage, 15% down payment). This scenario could have you paying less PMI than a 95-5 ratio (i.e. 95% mortgage, 5% down payment).
Amount of the loan :
The size of the loan is one of the main factors that influence the PMI. This is because the more money you borrow, the more risk there is for the lender should you stop paying.
Petrowski says each lender will have slightly different ranges for the PMI depending on the size of the loan, but generally speaking, if you borrow more, you can expect to pay more.
“The better your credit score, the better your [PMI] the rate is going to be,” Ide says.
Your credit score is an important measure for any type of financial transaction. It tells the lender how reliable you have been in the past and how risky you will be as a borrower.
A better credit score will generally result in lower PMI payments, according to Ide and Petrowski. For example, a credit score of 750 would likely place your PMI toward the lower 0.58% range; a lower credit score of 600 could push the cost further towards 1.86%, the high end of the range.
But again, each lender will calculate the cost slightly differently, say Ide and Petrowski.
Type of mortgage:
Private mortgage insurance is generally the cheapest with conventional 30-year mortgages, Ide says. Mortgage insurance may be higher with government-backed loans, such as FHA or USDA mortgages, where rates are set by the government.
Borrowers with lower credit scores can often be approved for government loans when they don’t qualify for private loans, which is another reason why government loans can have a higher PMI.
“If you’re more in that type of position, your money is a little tight and your score isn’t that good, which is why more people are turning to FHA loans more,” Ide says.
The PMI may also be higher on jumbo or construction loans, Ide says, again because these mortgages tend to be more risky.
Should I avoid private mortgage insurance?
Private mortgage insurance is a hotly debated topic in the world of personal finance. On the one hand, accepting the PMI makes it possible to move into housing with a lower and more accessible down payment. But on the other hand, it increases your monthly mortgage payment.
“People think it’s a waste of payment, and the extra they pay monthly doesn’t do anything for them,” says Ide. This argument suggests that the PMI only helps the lender while increasing costs for the borrower.
However, the PMI can open access to property for people who do not have a 20% down payment. And once a homeowner enters a property, there’s always the option to refinance down the line, rent out a room in the house to earn passive income, or improve the house and get a great return on investment when he sells the house later. Dated. Each situation is nuanced and specific to the individual, but some see PMI as just a cost that brings a greater good.
So the PMI is a good tool to have, says Ide: “It makes some properties more affordable, and I don’t think it’s that expensive for what it is.”
Also, the PMI doesn’t last forever, according to Petrowski. It can be removed once you pay off enough mortgage so you have at least 20% equity in the home.
“I don’t think that’s necessarily the dirty little secret you need to avoid,” says Petrowski. It all comes down to what matters most to you. If your goal is to own a home as soon as possible, PMI might just be an option to do so. For people who care strictly about numbers, choosing PMI may not make sense because it makes homes more expensive in the long run.
“If you’re really close to saving the 20%, it might be worth waiting a little longer and saving that extra money,” says Petrowski.