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  • Alexander Wissel

Escape the PMI Trap: The Sneaky Mortgage Fee That Could Be Costing You Thousands

Say Goodbye to PMI

  • What is PMI and why is it important for new home buyers to understand

  • What are the different types of PMI and how does it differ from MPI, and what is the impact on your loan.

  • How is Homeowner’s Insurance different from Private Mortgage Insurance and what policy protects me.

Escape the PMI Trap - Source:
Escape the PMI Trap

Mortgage Insurance, or Private Mortgage Insurance (PMI) is a cost that shocks many first-time home buyers. Many new home buyers neglect to add this expense to their calculations when they are estimating how much it costs to buy and own a home.

The home buying process can be overwhelming, and it’s understandable – there is a lot to learn in a short amount of time. In this article we are going to do a deep dive to get you as much information as you’ll ever need about mortgage insurance and PMI.

Private Mortgage Insurance, called mortgage insurance or simply PMI, is a lender required expense. It is a private insurance policy paid by the borrower to protect the lender in the event the buyer defaults on their mortgage. It is typically required for conventional loan borrowers who put down less than 20% of the purchase price.

What is Mortgage Insurance?

Mortgage insurance is just that – it is an insurance policy that protects the lender in the event the buyer/borrower defaults on the mortgage by walking away from home and/or stopping the monthly loan payments.

A single borrower defaulting on their mortgage can impair a banks capital. Hundreds or thousands can sink even the strongest financial institution. So there is a systemic need to protect the ability of banks to offer mortgages. (The past decade has clearly shown there are many ways to disrupt and cripple a bank...)

Private mortgage insurance has existed in its current form since 1957 when the first PMI firm was founded. The Mortgage Guaranty Corporation (MGIC) was created to give lenders an alternative to Federal Housing Administration (FHA) lending. At the time, FHA underwriting and restrictions created a bureaucratic process that made acquiring mortgage insurance hard.

The roots of mortgage insurance date even older –They go back to the pre-Depression Between all of the insured and government backed loans that PMI, the FHA, USDA and VA cover, they stabilize the housing markets.

Private Mortgage Insurance – separate from government backed loans – has the effect of reducing the strain on government sponsored entities (GSEs) like loan giants Freddie Mac and Fannie Mae.

How Much is Mortgage Insurance Premium?

So how much does PMI cost? Your private mortgage insurance rates can range from as low as .02% to up to 2%. The amount is based on a number of factors: your debt-to-income ratio, your credit profile, the amount of your down payment and your loan-to-value.

The less you put down, the higher the risk for the bank, and the higher premium you are going to pay.

There can be a huge range for PMI premium costs. To put it in perspective, on a $500,000 loan that would mean the cost could be as low as $1,000 to $10,000 a year. That’s roughly $83 to $833 a month. That’s quite a big range.

What Drives Mortgage Insurance Costs?

As we mentioned before, one of the biggest driver for your mortgage insurance premium comes down to your credit score. It’s the ultimate metric to measure your credit risk. If you have the lowest credit, you’re going to pay the highest rates.

That’s why that is makes sense for many borrowers with lower credit to get an FHA mortgage. The Urban Institute estimates that a borrower with a sub-720 credit score, who is putting down 3.5% will actually pay less with a FHA mortgage than a Conventional one with PMI.

What Kinds of Loans Require PMI?

It’s worth understanding that not all loans require private mortgage insurance. In fact, only conventional loans require PMI. The U.S. Government provides mortgage insurance through loans by the Federal Housing Administration (FHA), the U.S. Department of Agriculture (USDA) and the Department of Veteran Affairs (VA).

FHA loans require an upfront mortgage insurance premium (MIP) of 1.75% of the loan amount. In addition there is an annual MIP that varies based on the term, down payment, and loan amount.

VA loans do not have a mortgage insurance, but do require borrowers to pay a funding fee. USDA loans require a up front guarantee fee and an annual fee.

Why Do I need Mortgage Insurance?

You, technically, don’t need mortgage insurance. But your lender will require it... It is something that protects the company offering you a loan or a mortgage on your home. This is a private insurance policy written through title companies on behalf of the lender.

These polices cover homes when the borrower owns less than 20% of their home. Many consumers don’t realize that in the event a home is possessed by a bank, the value is generally written down to 65%-80% of it’s retail value. That policy will help make the ban whole, and not you.

Another fun fact is that in the event the bank does sell the home for more than they are owed – including penalties and fees – that the old homeowner would receive a check for their remaining equity.

Does PMI Protect You in Any Way?

Well yes. But only in the broadest sense. PMI protects you and the rest of the borrowers in the United States… By ensuring that the system doesn’t crash. The entire principle of insurance is the spreading of risk. By spreading the risk of mortgage defaults to private insurers instead of just the government, we can build resilience into the loan markets.

Although to a causal observer it seems like that didn’t happen in the 2009 financial crash. But it did, a little. From the bottoms of 2007-2009 to the resurgence of housing in 2012, our housing market has mostly recovered.

Are There Any Tax Deductions for PMI?

In the past few years there have been deductions tax-payers could use for their PMI expenses. From 2007 to 2021, there was a deduction that could be taken. Unfortunately, this was discontinued for the 2022 tax year. As of this article’s writing, there have been no announcements whether the 2023 tax year will enable homeowners to deduct their PMI payments.

What types of PMI are there?

There are a number of different types of PMI or private mortgage insurance. The biggest difference between them comes down to how the payment is collected. There are four main types of private mortgage insurance

Borrower-Paid Mortgage Insurance

This is the most common type of private mortgage insurance. Borrower-paid PMI is where a buyer is paying a monthly amount – usually wrapped up in their PITI payment). A borrower generally pays a single amount to their loan servicer which is comprised of Principle, Interest, Taxes, Insurance. Insurance generally refers to both private mortgage insurance and homeowners insurance. We’ll get to homeowner’s insurance in a moment.

Single-Premium Mortgage Insurance

A Single Premium PMI is exactly like it sounds – you are making a single payment at closing.

For borrowers who are concerned about their monthly payment this is a good option.

Often this single premium can be a much smaller amount vs the cumulative expense you would end up paying monthly. However, in the event you sell your home before your equity increases, you’re ‘forfeiting’ that amount by leaving early.

Lender-Paid Mortgage Insurance

It might surprise you to know that your lender can pay your mortgage insurance costs. This can happen for a couple of reasons. In rare cases where a mortgage company is hungry for business, they can offer it as an incentive to sell more loans.

For mortgage companies without a physical bank location, who just use mortgage brokers or independent loan officers with multiple bank options, it can help drive sales to their firm. All things being equal, you will generally pay by having a higher interest rate.

Split-Premium Mortgage Insurance

When you have split premium insurance, you pay both upfront and monthly. The benefit of doing this is that you can take advantage of lower monthly costs and a lower up front cost. Split premium PMI can help buyers who are sensitive about monthly costs but who don’t have the ability to buy out their PMI outright.

How is PMI Different than Homeowner’s Insurance

Homeowner’s Insurance is something that we have a lot of experience with, as I was an Insurance agent for almost 8 years. Homeowner’s Insurance is not PMI. Homeowner’s Insurance protects your home, and your belongings in the event of a catastrophic accident.

Homeowner’s Insurance is the insurance policy that protect you, while private mortgage insurance protects your lender.

They do have some similarities however. Both are required to be escrowed for if you own less than 20% of your home. Homeowner’s insurance – and the protections it gives – are a requirement by your lender to have. Lenders want to make sure your home would be rebuilt in the even their was a fire or accident.

Often they get grouped together in the PITI calculation.

Pro’s and Con’s of PMI

Pro’s of PMI – Any time you have to add more expense on to a purchase it can be hard to find the benefit. Private Mortgage Insurance is no exception. But there are some upsides to it.

The biggest thing that most buyers saddled with PMI payments many not understand is that PMI allows people to buy a home faster. If you had to save for 20% down it might take a prohibitively long time to do so.

The biggest benefit – you could argue that this outweighs all the negatives – of private mortgage insurance is that it helps buyers who don’t have enough money to buy a home faster.

Another good thing about PMI is that it’s not forever. PMI can be removed faster if values rise quickly. We had a client buy in 2019 with roughly 5% down, and because of the boom in prices, they were able to remove PMI by the 2022.

Con’s of PMI – Let’s get into the negative aspects of PMI. On the flip side of my clients above who were able to remove it in just 3 years, there are homeowners who have it for a long time. If prices flatline, it can take a lot longer to build up that 20%. PMI can take many years to get rid of it.

The biggest downside to PMI is that it adds an additional cost to buyers purchase price or monthly payments. We see this being a problem for lot of first time homeowners who are doing to numbers themselves. They aren’t adding in the additional cost of PMI. It’s also why we always tell buyers to get a good, local, loan officer early in the process.

Should I Put Down 20% or pay PMI?

This is a great question to discuss with your lender and/or financial advisor. Everyone’s situation is slightly different and for some buyers it may make more sense to pay PMI and keep a larger cash reserve.

The benefit of paying off your PMI might be offset if you need to make substantial improvements to your home. If you are, it might make sense to make improvements and get your home re-appraised.

All things being equal, and if you can afford the 20% down – yes, it can make a lot of sense to pay the money to avoid the extra expense of PMI.

How do I Get Rid of PMI?

There are a couple of ways to have get rid of your PMI or MIP – which are dependent upon who your mortgage is through. You can request your loan servicer to cancel your PMI once the equity reaches 20%.

But there are other considerations. You’ll need to be current on your payments. In addition, you generally can’t have home equity line of credits, or second mortgages that reduce your equity percent. Remember it the total about of equity you own. It doesn’t count if your first mortgage is only 18% of your equity but your second mortgage is 5%.

Refinance Your Home

If you want to get rid of PMI or MIP, you could refinance your home. By refinancing you would hopefully be getting a better rate, or reducing your term in years that you’ll make payments. As part of that process you would would have your home appraised and pay closing costs associated with the refinance.

Always consider the ramifications of the closing costs – refinancing can add additional debt on to your mortgage – and whether the numbers make sense.

Have your Home Reappraised

Your loan servicer can give you specific details on the process, but generally it starts with getting an appraisal that shows you have equity of 20% or more. Getting your home appraised is just as much about the local comparable properties as it is about your home.

An appraisal can cost anywhere from $300 to $1,100 depending upon the type of home, how difficult it is to ‘understand’ and where it is located.

Make Payments and Wait

If you’ve been paying consistently and your home is in a flat market, you can make the calculation based on your original mortgage amount. When you reach 22% of your home’s equity your loan servicer must automatically cancel it.

You can check if you’ve reached that threshold based on your payment history. In cases where you’ve made substantial additional payments or have been paying for a bit, once your equity hits 22% it should automatically come off.

We don’t suggest waiting that long. It’ never hurts to check an see what your loan servicer is calculating for your homes value and home much equity you have stored.

Our Love / Hate Relationship with PMI

Okay not many people love PMI, but it serves a systemic purpose and helps buyers get into homes faster. Understanding the ins and outs of PMI can help you purchase a home and keep your expenses at a minimum.

Hopefully this guide gives you a little more information to help make better decisions when you’re looking at home financing options.



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