Lenders do what they can to make sure borrowers pay back their mortgages. That’s why most lenders only approve people with great credit scores. Lenders typically want people to put down at least 20% of the value of the home. However, it is possible to get a mortgage if you don’t have 20% of the down payment. How? PMI.
PMI (or private mortgage insurance) is designed for borrowers who don’t have a big enough down payment. According to the US Dept. of the Treasury, private mortgage insurance covers the costs of foreclosure if the borrower is no longer able to make payments on the loan. While PMI protects the lender, it’s the borrower who needs to pay.
How it Works
If you put less than 20% down on a home and have a conventional mortgage, expect PMI to be part of the deal. How much you’ll have to pay monthly or upfront depends on a few factors (such as how much you put down). The higher your down payment, the lower your insurance premium. The higher your credit score, the lower your premium.
Typically, the cost of premiums ranges from 0.3 to 1% of the initial value of your loan. So, if you have a premium of 0.5% and borrow $200,000, you can expect to pay $1,000 per year in premiums.
According to the Consumer Financial Protection Bureau, there are three ways to pay your private mortgage insurance premiums. You can pay a portion each month, make a lump sum payment when you close on the house or make an upfront payment and pay a portion of the premium monthly.
Are You Stuck with It?
The good news about PMI is that it isn’t permanent. You aren’t left paying an extra 1% every year for the life of the loan because you couldn’t put 20% down. Once you’ve made enough loan payments to make the value of your mortgage 80% or less than the value of your home, you can ask the lender to cancel your insurance. However, it’s important to note the following caveat: The lender doesn’t have to cancel your insurance at that point. If the value of your home has fallen since your purchase, you might not be able to cancel.
Private mortgage insurance should automatically terminate once the balance on your principal reaches 78%. Alternatively, if you make it to the halfway point of your repayment schedule before the principal falls to 78% of the home’s value, your PMI should automatically terminate.
Private mortgage insurance is common—however, it isn’t a requirement for those who can’t put 20% down. For example, your lender might charge you a higher interest rate instead of requiring insurance. You can also explore other loan programs (such as an FHA loan or VA loan).
In any case, if you have questions about your loan options, make sure to talk to a mortgage specialist to learn more about your financial possibilities.
Image Source: Pixabay