The excitement and joy you feel when making an offer on a new house can quickly turn to frustration, confusion, and a general sense of overwhelming once you start reviewing the paperwork. If this is your first house, there are probably a lot of terms you don’t understand. Even if this is your second, third, or fourth house, you might still be confused by all the factors that your lending company uses to determine how much money to lend you and what type of loan is the best for you.
One of the most commonly asked questions I get asked is: “What is mortgage insurance, and do I need it?” So let’s take a moment to explore Private Mortgage Insurance (PMI), why it might be necessary in order for you to qualify for a loan, and whether or not it benefits you, the buyer, in any capacity.
In this blog, we’ll discuss what PMI is, why it’s used, how it’s factored, how you can avoid it, whether or not it’s a permanent fixture within your mortgage, and how it affects you, the borrower. As always, if you have any additional questions that you’d like to discuss in detail, please feel free to reach out to me. It’s important that you understand every aspect of your mortgage so that you’re able to make an informed decision for you and your family.
What is Private Mortgage Insurance (PMI)?
According to the Consumer Financial Protection Bureau (CFPB) “Private mortgage insurance, also called PMI, is a type of mortgage insurance you might be required to pay for if you have a conventional loan. Like other kinds of mortgage insurance, PMI protects the lender—not you—if you stop making payments on your loan.”
Most PMI rates range from 0.5% - 1% of your total loan amount and will be automatically figured into your monthly payment plan. However, your lender might have an option for a one time upfront payment of the total amount, so you may want to find out if this is an option for you.
Most lenders require PMI unless you are able to put a minimum down payment of 20% on your home. While it’s easy to say that PMI does nothing for you, the purchaser, it does allow you to take a mortgage out if you’re unable to meet that 20% down requirement.
How do you Pay for Private Mortgage Insurance?
The good news is that you don’t have to pay upfront or schedule separate payments to manage your PMI. Your lender will automatically factor this into your monthly mortgage payment, making the process seamless and painless for you.
Keep this in mind as you’re reviewing paperwork and signing documents. Your PMI will be outlined within your documents, although most of the time it won’t be discussed with you as you’re reviewing paperwork and being pre-approved. Most lenders will assume you’ve done your homework and are already aware of the factors that go into your mortgage and payment schedule calculation. However, they will be happy to discuss with you if you have additional questions regarding line items and how the numbers are calculated.
For this reason, I highly recommend that you do research ahead of time and know what to expect. Question terms you don’t understand and never be afraid to ask for more information. While you may not be able to avoid the addition of Private Mortgage Insurance into your mortgage, you can gain a good understanding of it and how you could avoid it in the future.
There are some great resources available that can help you know what questions you should be asking your lender. Please take the time to review several of these prior to beginning the process of looking for a mortgage lender. It will save you time and frustration.
Avoiding PMI
The easiest way to avoid Private Mortgage Insurance is to save up for that 20% down payment. If you’re just beginning to look into buying your first home, then I strongly encourage you to take this into consideration. While you may not know exactly how much you’ll need to save up, you can use several factors to make a pretty good guess.
Interest Rates in your Area
Average Home Prices in your Area by Preferred Neighborhood
Preferred Home Size
If you consider all of this, you will have a pretty good idea of how much money you need to save up in order to afford a 20% down payment on your first home and you can implement a plan on how you’re going to save up that money prior to house hunting. (This is key - if you don’t think you’re financially ready to buy a house, don’t start looking at houses in detail! Falling in love with a house could lead to you making decisions that aren’t in your best interest.)
Alternatively, some individuals have taken out a secondary small loan to pay for the 20% down payment in order to avoid PMI... but this can get tricky, especially if you’re not taking that loan’s interest rate into consideration. It may be in your best interest to simply accept the 0.5 - 1% Private Mortgage Insurance rate to save yourself some additional stress.
Removing PMI from your Mortgage
As you settle into your new home, there may come a time when you can request that your lender remove the PMI from your mortgage. The best time to do this is when your loan reaches 78% of the home’s original value or when you’ve paid 20% of your home’s principal (not including interest, insurance, tax, etc). This will require that you put in a request with your lender and could take a bit of time to resolve, but it might be worth it for you if you’re looking to reduce your monthly bills.
If you bring this up with your lender as you’re initially filing the paperwork to purchase your home, you might have an easier time down the road when you think you’ve met the requirements necessary to drop your PMI.
Click Here for more ways to remove PMI from your mortgage.
What Private Mortgage Insurance is Not
PMI’s sole purpose is to protect your lender in case you fall behind on payments or default on your loan. It does not cover your missed payments and will not protect you from your lender taking foreclosure action against you. If you are struggling to make payments, particularly during this time of COVID-19 and the employment obstacles it has brought, contact your lender. They may be able to work with you or offer some additional options and resources for assistance.
It’s always best to reach out to your mortgage lender prior to a late payment or missing a payment. Give them the opportunity to make an arrangement with you instead of reacting after the fact. You can avoid some negative consequences by being proactive, and you may have more options than you think!
Conclusion
So while PMI is implemented to protect your lender, it does allow people who aren’t able to produce that 20% down payment the opportunity to invest in a new home. Overall it doesn’t make much of a difference in your monthly payment schedule but enables lenders to “take a risk” which can help quite a few individuals out - especially if you’re hoping to purchase your first home.
Remember that it’s okay to ask questions - even if unsure of what questions you should be asking. If you don’t recognize a term or don’t understand how a number was calculated, bring it up to your lender. By addressing questions and concerns from the get-go, you will save yourself countless headaches later on down the road.
Even doing a quick Google search prior to meeting with your lender can help you be better prepared to tackle and understand the entire process of acquiring a mortgage loan and financing your first (or second or third) home. Don’t be afraid to print out questions, jot down notes or thoughts you have so that you can remember to ask them later, or even to ask them to start their explanation over again if you’re still not following them.
A good mortgage lender will want you to understand the process so that you can make the best financial decisions for you and your families’ future so that you don’t run into any issues down the road. An informed borrower who has all the data and information is far less likely to fall behind on their payments or take on too large of a loan.
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AUTHOR BIO
Will Foster | First State Bank Mortgage Senior Loan Officer
I became a mortgage lender in 2010, right after the "bubble" popped, and the mortgage industry underwent an incredible transformation. This has given me a unique advantage in the fact that I have never known anything other than the highly-regulated world we now live in.
Throughout my years of experience, my primary goal has been to keep up with the constant changes in the industry so I can help my clients investigate all of their options and maximize savings. In addition, because I specialize in Conventional, FHA, USDA, Jumbo, portfolio, and VA refinances and purchases, I can help a wider variety of individuals, families, and investors identify and secure the right loan to best suit their future interests.
The mortgage process can be a little confusing and even overwhelming these days with all of the regulations. I guide my clients through the process from start to finish, and I try and make it as painless and hassle-free as possible.