What is Private Mortgage Insurance or PMI? PMI is an insurance paid by you the borrower to protect the lender if you the borrower defaults on your loan. What causes you to have PMI? Easy answer, any time you put less than 20% down on a conventional loan you will need to carry some form of PMI.
Most people have heard of the term PMI, and most people think it is bad and immediately want to avoid it. Many articles on the internet will recommend the same. I on the other hand have a little bit of a different of opinion. PMI on a loan is no longer a taboo, actually a huge majority of the consumer market today carries PMI on their loan.
Now let's talk about the two most common types of PMI:
- Monthly MI or Borrower Paid - This is the most common option, it is simply added on to your monthly payment just like your taxes or home owners insurance would be to increase your overall monthly payment. (This can be removed, and we will talk about that later)
- Lender Paid MI or LPMI - This option has lost popularity over the last few years, in this option you are just taking the MI rate and adding it to your interest rate. Quick example your rate was going to be a 3% but the LPMI cost is 1%, now you have a 4% interest rate but you are not paying monthly MI as a separate part of your payment. (This cannot be removed, and we will talk about that later)
In most cases I would recommend you the client taking the Monthly MI option. The why for this is you get more flexibility with removal in the future.
Now for the Pros and Cons to having PMI: (Keep in mind this is all generally speaking)
- Lower Down Payment
- Lower Interest Rate Options
- Can be removed down the line
- May be tax deductible (ask your tax prep individual)
- Higher Monthly Payment
- Can restrict how much home you can have
- Depending on MI type selected could increase rate
- Depending on MI type selected may not be removed down the line
So why do I think having mortgage insurance is not a bad idea? Let's dig in to a quick example.
You are buying a home for $300,000 and have the option of putting 5% down, or putting 20% down. When we look at just straight cash we are talking taking $15,000 out of your pocket or $60,000 out of your pocket. A difference of $45,000!!
Let's discuss how long it would take for you to recoup your investment. Let's say in this same example you are paying an extra $200 a month between your Principle and Interest payment plus your PMI payment doing 5% down instead of 20% down just to avoid MI.
It would take you the borrower almost 19 years to recoup the $45,000 you had to spend out of your pocket. Anything that takes you almost 20 years to recoup is not a great deal. Having the extra $45,000 in your pocket allow you to make home improvements, invest, pay off debts and have a safety net if anything financially comes up in your life.
I know what you are thinking, but the other way I would have equity!! I need equity!! I want you to do me a favor next time you go to the store and hit the check out line see if the cashier will take your equity as payment. I bet they are going to look at you like you are crazy. Also we cannot forget that equity is made up, the equity you have today could be gone tomorrow, but the cash in your pocket, or in the bank, or under your mattress doesn't go away unless you use it.
PMI removal - so with all the factors I mentioned above we also have the ability to remove your PMI if you have taken a monthly MI option.
How to remove PMI?
- Reach 80% LTV - Once you reach 80% LTV you can request PMI to be removed from your lender.
- Reach 78% LTV - Once you reach 78% LTV your lender must remove PMI from your loan.
- Refinance your loan - You can always refinance if you feel your home is worth more, and you want to change your rate.
- LPMI does not allow you to remove PMI because you bought it in to your rate, so your only option is to refinance your loan.
Imagine if you spent an extra $45,000 when the current market within a few years would have allowed you to remove PMI naturally with inflation. You are going to wish you had some of that cash back.
Final thoughts on PMI.
I think if you have the option to put enough money down to remove PMI or keep it, just keep it. Save yourself the money in your pocket, be prepared for life experiences because they will sneak up on you when you least expect it.
I will use my real life loan to paint the final picture. My wife and I bought our home 3 years ago and put 5% down, instead of the 20%. In the last 3 years are home value went from $340,000 to $395,000. I was able to remove PMI, get under 80%, and only paid a higher monthly payment for 3 years. I was still able to keep a big chunk of cash in our account that was used to make upgrades to the home.
At the end of the day always do what is most comfortable to you and your family, every one has a different comfort point on their loan, and it is up to you and your mortgage professional to make that determination. Always always always speak with a mortgage professional to know your options.