If you recently looked at homes or have inquired about the homebuying process, you’ve likely heard the term Private Mortgage Insurance, or PMI. But, what is PMI on a mortgage and how does PMI work?
For starters, PMI is a type of insurance that protects the lender if a borrower cannot provide a 20% down payment on a property, which can make the mortgage a riskier investment for a lender. However, it’s a small price to pay to make low to no downpayment options accessible for more hopeful home buyers.
Let’s take a look at the ins and outs of PMI to help you better understand this important aspect of a mortgage.
What is PMI, and how much does it cost?
As stated above, PMI is a type of insurance added to a mortgage when a borrower cannot afford a 20% down payment. When we underwrite your mortgage, a portion of the process includes determining your loan-to-value ratio (LTV). To determine your LTV, divide the amount of your mortgage by the value of the property. Typically PMI is necessary if the LTV is more than 80%, which protects the lender from potential losses in case you default on your loan. For example, if your home value is $300,000 and you put $30,000 down, your LTV is 90%, and you will need PMI.
If you need PMI on your mortgage, you should anticipate paying somewhere between 0.55% up to 2.25% of the loan value annually. Factors such as your credit score, LTV, and debt-to-income ratio determine the percentage. We can help calculate the exact amount of PMI that you can expect to pay based on the criteria mentioned above.
Usually, this amount will be divided among 12 months and added to your monthly mortgage payment. In other instances, PMI may be paid in one lump sum and included in closing costs.
When do PMI payments stop?
A common misconception is that PMI remains on the loan for the entirety of its term. However, you can request your loan officer to remove PMI once your LTV ratio reaches 80%. Furthermore, if you do not request this removal, OVM Financial and all mortgage lenders will remove PMI once your LTV hits 78%. Learn more about eliminating PMI for each loan type.
Tips for saving on PMI
Fortunately, there are ways to keep your mortgage more affordable if you’re concerned about the amount of PMI you would be required to pay.
Save a 20% down payment.
Having at least 20% of the home value for a down payment will help you avoid PMI altogether, saving you thousands of extra dollars over the life of your loan. If you’re able to hold out and save for a longer period of time, it may be worth it in the long run.
Make extra payments toward the principal.
Apply additional payments to your principal balance to get your LTV ratio closer to the 78% mark. As mentioned above, you can eliminate PMI when you reach this benchmark.
Search for loans with no PMI requirement
Some government-insured loans such as FHA, USDA, and VA loans come with no PMI requirement. If you qualify for these types of loans, they may be a good fit for your financial situation. But it’s important to keep in mind that these loans come with requirements of their own.
Search for down payment and closing cost assistance programs
Most states offer down payment assistance programs that can help homebuyers become homeowners. If you qualify for the programs, you can receive hundreds or even thousands of dollars to put toward your new purchase, reducing your LTV ratio. You can also look into closing cost assistance if you cannot find a down payment assistance program or your state does not offer one. If you receive funds for closing costs, that means you can put the funds you had set aside for your closing costs toward your down payment instead.
The bottom line
While you may be itching to get the keys to a new abode you can call our own, it’s extremely important to consider all financial factors of borrowing a mortgage. This means taking a look at your entire financial picture to determine whether or not it would be better to save a 20% down payment, or if you can afford the extra PMI payment each month. Either way, we are here to help and guide you through your journey to homeownership! Give us a call or start your application today.
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