When you buy a home with less than 20% down, you will have private mortgage insurance (PMI). If you buy a home with an FHA loan, PMI is permanent. If you buy a home with a conventional loan and put less than 20% down, PMI is permanent until you gain enough equity for it to fall off, which typically takes 7-11 years. There’s no way around it…your mortgage loan and PMI are a packaged deal. However, there are other ways you can pay for private mortgage insurance besides adding it onto your monthly mortgage payment. Let’s get into private mortgage insurance and how you can avoid it!
*There are scenarios where a borrower has put less than 20% down and didn’t have to pay for PMI. While this is great, interest rates are far from the low 2%-3% range back in 2020. As rates increase, the gap between borrower paid PMI and lender paid PMI has grown drastically. When rates are low, lenders are more likely to offer lender paid PMI.*
What is PMI?
Private mortgage insurance is required for borrowers who put less than 20% down on a home. It serves as a precaution that protects the bank from missed mortgage payments and foreclosures. PMI covers the cost to foreclose on the property, which ends up roughly being 13%-26% of the purchase price.
Here’s a monthly PMI payment example:
-You put down 5% on a conventional loan amount of $475,000 with a 3.25% interest rate.
-Monthly principal & interest payment= $2,067
-Monthly PMI payment= 0.44% or $174
-Total monthly mortgage payment= $2,241
Home Equity
This is an option for borrowers with either an FHA or a conventional loan who don’t put 20% down and have to pay for PMI. There are a few strategies to pay off or remove PMI using home equity.
Conventional
-Wait 7-11 years for PMI to automatically fall off after you’ve paid off 20% of the original purchase price.
For example:
-You put 5% down and it takes 7 years to reach 20% principal pay off from the original purchase price.
-That’s $14,000 total you’ve paid in PMI.
FHA
-Wait 2-4 years to gain 20%-25% equity from the new value of the home based on current principal payoff amount and appreciation at an annual average of 4%.
-Refinance the FHA loan to a conventional loan and use that equity to remove PMI.
-If you never refinance on a 30 year FHA loan, you’ll end up paying a total of $240,000 for PMI (based on this scenario).
Lender Paid
This is an option for borrowers with a conventional loan who put less than 20% down. A lender will offer a higher interest rate to cover the cost of PMI.
For example:
-You put down 5% on a conventional loan amount of $475,000 with a 3.25% interest rate.
-You take a higher interest rate at 3.75% for lender paid PMI.
-Monthly mortgage payment = $2,233
-That’s a total of $330,000 paid towards interest on a 30 year conventional loan without refinancing or selling.
With this option, you save $8 on your monthly mortgage payment, BUT you end up paying $60,000 more towards interest than if you take a lower rate and just pay the monthly PMI.
Single Premium
This is another option for borrowers with a conventional loan who put less than 20% down. With single premium PMI, borrowers make a one time payment to pay off PMI upfront.
For example:
-You put down 5% on a conventional loan amount of $475,000 with a 3.25% interest rate.
-Monthly principal and interest = $2,067
-Single premium charge= 1.59% of the $475,000 loan amount.
-That’s $7,552.50 out of pocket to pay off PMI.
Now, you can compare this payment option with monthly PMI and see which option fits your budget based on your scenario.
Monthly
Let’s compare the cost of paying monthly PMI to the alternative costs of removing monthly PMI to help you figure out the best option for your scenario.
Lender paid
-Lender paid PMI is $8 cheaper a month but keep in mind that higher interest rate is technically forever. With the higher interest rate, more of your money goes towards interest and less towards principal.
-If rates get better down the road, you can refinance down. However, refinancing has closing costs that might total more than the single premium PMI charge. If rates get worse, you’re stuck paying the higher interest until the end of the loan or until rates improve. Remember, that’s $60,000 more towards interest compared to monthly PMI and single premium PMI!
Single premium
-You pay the monthly PMI, which is relatively inexpensive in comparison, but you’re taking a gamble. You wait 2 years until you have 20% equity based on principal pay off amount combined with home value appreciation and ask your lender for a refinance loan to remove PMI. This is cheaper than a single premium PMI.
OR
-If home value appreciation doesn’t increase enough to gain 20% equity after 2 years, you get stuck paying the monthly PMI for about 5 more years. This makes single premium PMI the cheaper option.
-The breaking point to paying for monthly PMI is when payment hits over 43 months. After 43 months, it becomes more expensive than single premium PMI.
Bottom Line
Now you know different options for avoiding PMI when you put less than 20% down. Paying for PMI might not be the worst option, it all depends on your situation. The best way to find out is to reach out to a lender and run the numbers or reach out to me!
