Private Mortgage Insurance (PMI) is an additional cost that applies to homebuyers who make a down payment of less than 20% on their home. It’s essentially insurance for the lender, protecting them if you default on the loan, but the premiums are paid by you, the homeowner.
Freddie Mac defines PMI as:
“An insurance policy that protects the lender if you are unable to pay your mortgage. It’s a monthly fee, rolled into your mortgage payment, that is required for all conforming, conventional loans that have down payments less than 20%. Once you’ve built equity of 20% in your home, you can cancel your PMI and remove that expense from your mortgage payment.”
As the borrower, you pay the monthly premiums for the insurance policy, and the lender is the beneficiary. Freddie Mac goes on to explain that:
“The cost of PMI varies based on your loan-to-value ratio – the amount you owe on your mortgage compared to its value – and credit score, but you can expect to pay between $30 and $70 per month for every $100,000 borrowed.”
According to the National Association of Realtors, the average down payment for all buyers last year was 13%. For first-time buyers, that number dropped to 7%, while repeat buyers put down 16% (no doubt aided by the sale of their homes). This just goes to show that for a large number of buyers last year, PMI did not stop them from buying their dream homes.
Here’s an example of the cost of a mortgage on a $200,000 home with a 5% down payment & PMI, compared to a 20% down payment without PMI:
The larger the down payment you can make, the lower your monthly housing cost will be, but Freddie Mac urges you to remember:
“It’s no doubt an added cost, but it’s enabling you to buy now and begin building equity versus waiting 5 to 10 years to build enough savings for a 20% down payment.”
One of the best ways to save money is to eliminate PMI as soon as possible. Lenders are required to cancel PMI automatically once you reach 22% equity in your home, based on the original purchase price. You can also request cancellation when your equity reaches 20% if your loan is in good standing. Alternatively, you could refinance your mortgage to remove PMI if property values have risen significantly in your area.
For some homeowners, PMI payments may be tax-deductible, but there are income limits. If your adjusted gross income is $100,000 or less, you can deduct the full cost of PMI premiums. However, this deduction phases out as income approaches $109,000 and is not available if you earn above this threshold. This benefit can provide some financial relief, but it’s crucial to consult a tax advisor to confirm eligibility
While paying PMI might feel like an extra burden, it allows you to purchase a home sooner without saving for a large down payment. Over time, as you build equity, the cost of PMI will no longer be necessary. For many, the ability to enter the housing market sooner and benefit from property appreciation outweighs the temporary cost of PMI.
PMI can be both a stepping stone and an additional expense. By understanding its costs and strategies for cancellation, you can make the most of your investment while minimizing unnecessary financial strain. For more detailed information about PMI and its implications.
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