The True Price Of PMI

The following article originally appeared on Unison. 

If you put down less than 20 percent in cash on your conventional mortgage loan, chances are that you should plan to pay private mortgage insurance.

Private mortgage insurance, or PMI, sounds like it might be a helpful protection against something happening to your mortgage. And it is — but for your lender, not for you.

The policy protects the lender if you stop making payments on the loan or end up in foreclosure. Even though the lender is the beneficiary of the policy, you as the homeowner must pay the monthly premiums.

Here’s what you need to know about how it works and how much it costs to pay PMI.

Where Do You Pay PMI — and How Much Does PMI Cost?

The PMI cost is usually rolled into your monthly mortgage payment, along with principal and interest, property taxes and your homeowner’s insurance premium.

How much PMI costs depends on a few different factors, but you can generally expect to pay a monthly premium of $30 to $70 for every $100,000 that you borrowed, according to Zillow.

Many lenders require a down payment of 20 percent in order to avoid PMI. Some homeowners determined to avoid PMI wait to save more money before buying, while others explore options like homeownership investment programs.

But depending on your financial situation, saving more could take years of work — and not everyone wants to invest in a home with a third party. In that case, you’ll need to face PMI as an added expense on your mortgage.

Breaking Down the Cost of PMI

Clearly, there are both pros and cons of PMI. We can use a specific example to better understand how PMI cost impacts the amount of money you need to pay each month on your mortgage.

Let’s say you buy a house and get a 30-year loan for $250,000 with an interest rate of 4 percent. Your monthly payment for principal and interest will be $1,194.

Let’s also say that you owe the following each month:

• Property taxes: $100
• Homeowners insurance: $80
• PMI: $125

Your total monthly payment with the $125 worth of PMI would be $1,499. Without PMI, you’d pay $1,374 per month.

PMI Isn’t Forever, But Removing It Isn’t Easy

While paying PMI isn’t ideal, you won’t be on the hook forever. You can request for the lender to remove PMI from your loan once you reach a loan-to-value ratio of 80 percent. That includes paying for an appraisal to prove your loan is indeed 80 percent of the home’s value.

If you wait, though, the lender is required to remove PMI automatically once the loan balance is 78 percent of the original home value.

Still, some lenders don’t remove this right on schedule. It’s important to know when PMI cost should drop according to your amortization schedule, and to call the lender to confirm PMI will come off your monthly payment when it’s time.

See how a home ownership investment can double your down payment.

Let’s use another example to understand how much you might pay in PMI cost. Going back to our previous example, we can say the original value of the home you bought was $293,750.

You took out a $250,000 mortgage, so in this case, you can request that the lender remove PMI once your balance reaches $235,000.

With a monthly payment of $1,194 (that’s your principal and interest), it will take you 40 months before you can request that the lender remove PMI. By this time, with a monthly PMI cost of $125, you’ll have paid $5,000 toward PMI.

If you believe a combination of your mortgage payments plus the home’s increase in value thanks to a good market makes your loan 80 percent or less of the home’s total value, it might make sense to hire an appraiser and request your lender take PMI off early.

Appraisals typically cost between $225 and $450, which would be well worth the cost if it meant you didn’t need to spend the full $5,000 in PMI that you would pay for if you simply waited for the premium to fall off as scheduled.

Should You Wait and Save 20 Percent for a Down Payment Instead?

While there are ways to put 10% down with no PMI, you can be sure to avoid PMI altogether if you simply save 20 percent or more for a down payment. That’s not always easy, of course. It could take you far longer to save that full amount before you buy.

There are risks to going this slower route, too. Imagine that it takes you 5 years to save the full down payment and you can then get a 30-year loan for $235,000 instead of $250,000 — but if interest rates rise during the years you’re saving, it might not be worth it.

Moving from a 4 percent interest rate to a 5 percent rate increases your monthly payment to $1,342 for principal and interest. You’ll also pay an extra $180 for property taxes and homeowner’s insurance, bringing your total to $1,522.

Of course, there’s no guarantee that this is how things will play out. It’s impossible to predict how interest rates will change, even in the short term.

The point is that any strategy you use for buying a house comes with risk, and some homeowners prefer to act sooner rather than leave their home-buying plans up to chance. If you really don’t want to pay PMI, you can research options for “no PMI” mortgage loans.

You can also consider working with Unison, who will match your down payment up to 10 percent. Unison partners with potential homeowners to make the purchase, and because it’s an investment, there are no payments or interest rates to worry about.

You can learn more about Unison’s program and how it works here.

How to Lower Your PMI

If you’re planning on putting down less than 20 percent on your mortgage, you’re not totally at the mercy of the lender as far as your PMI premium goes.

Since PMI is meant to protect lenders against default, they’ll charge higher premiums to borrowers who are more at risk of default. Having good or excellent credit means you’re less of a risk, so you’ll get a lower premium.

Learn how a home ownership investment makes it easier to buy a home.

If your credit isn’t stellar, look for ways to build your credit score so that you can qualify for a lower PMI payment. And as a result, you may even qualify for a lower interest rate and, therefore, a lower overall mortgage payment.

Make an Informed Decision

There’s no right answer when it comes to how much you should put down on your mortgage.

If you have enough for a 20 percent down payment, you won’t have to worry about the cost of PMI. But if you don’t have enough, it’s important to know how much it will cost you on a monthly basis and over the long run — or to know the alternatives available.

For your specific situation, use an online PMI calculator to find out how much it will cost you. Knowing those figures will help you make a more informed decision for your mortgage.