There is a cost to owning a home that surprises many first-time homebuyers, one that is easily overlooked in the excitement of the home buying process.
It is called private mortgage insurance or PMI. For the unprepared homebuyer, the cost of paying PMI can be a real budget breaker, adding thousands of dollars in additional costs each year.
Fortunately, with a little planning and advance knowledge, there are ways you can avoid paying PMI.
What is Private Mortgage Insurance (PMI)?
The purpose of private mortgage insurance is to protect the lender in the event that you default on your mortgage. If you are unable to make a minimum 20% down payment on a conventional home loan, your lender will likely ask you to pay PMI.
The advantage of PMI for home buyers is that they can buy a home without having to pay a full 20% down payment. At first glance, this may seem like a huge plus, as it saves the home buyer having to pay tens of thousands of dollars upfront and still allow them to buy a home.
But if you do your research before buying your home, you might find that the true costs of PMI far outweigh its benefits.
How much can PMI cost me per year?
Again, it’s important to emphasize that PMI is insurance that pays for the homeowner and protects the lender, not the homeowner. If you don’t make your mortgage payments, PMI will not intervene to make your payments for you.
Instead, PMI offers the lender some protection in the event that the homeowner defaults on the loan and the home goes into foreclosure. The rationale behind PMI is that if the lender has to sell the foreclosure home at auction to get its money back, then (according to foreclosure statistics) it will recover on average about 80% of the property’s value, and the remaining 20% will be covered by the PMI policy.
PMI premiums can be hefty, generally ranging from 0.55% to 2.25% of your original loan amount. How much you actually pay will depend on factors such as your down payment amount and your credit score.
For example, if your PMI is 2% and your loan amount is $250,000, you will pay $5,000 per year. Most people choose to pay PMI in monthly installments, meaning you’ll pay about $416 per month in this scenario. This is in addition to your mortgage payments, property taxes, homeowners insurance and maintenance costs.
Keep in mind that this is not a one-time expense, but an expense that you will have to pay as long as the equity you have in your home is less than 20%.
5 Ways to Save Money and Avoid Paying PMI
Given how expensive PMI can be, it’s no wonder many homebuyers like to avoid the expense. Here are five ways you can avoid paying PMI.
1. Shop around for a loan that doesn’t require a PMI
Look for alternative loan programs that either waive the PMI requirement and/or offer you down payment assistance. For example, VA loans don’t require a PMI, so if you qualify, you can save a bundle. Look at loans insured by the Federal Housing Administration (FHA) or the United States Department of Agriculture (USDA). Both agencies have programs that aim to make homeownership more affordable for low- and middle-income buyers.
2. Check out state and local homebuyer aid programs
More communities are making affordable housing a priority, and this includes developing new programs aimed at helping homebuyers. Some communities are focusing on what’s called “housing for the workforce,” with the goal of making home ownership affordable for people in certain occupations, such as school teachers, firefighters, or first responders. You can get started by checking out HUD’s local homebuying page for programs in your state.
3. Find a loan of 80-10-10
One strategy for avoiding PMI is to take an 80/10/10 loan where you put down 10% and take out a 10% line of equity credit and use that to meet the 20% down payment requirement, says Eric Simonson , founder of Abundo Wealth. The line of credit will likely be variable, so you want to prioritize paying off sooner, Simonson says. If you’re not sure how to find a lender that offers 80/10/10 loans, talk to your accountant or financial advisor who will likely be able to make recommendations.
4. Pay a higher interest
Some lenders offer loans that allow you to avoid PMI in exchange for a higher interest rate. You have to go through a qualification process, but if you are approved you will be allowed to deposit less than 20%. But your monthly mortgage payment will be higher — significantly in some cases — because you’ll be charged a higher interest rate.
5. Buy a cheaper house
Just because you’ve been pre-approved by a lender for a certain amount, doesn’t mean you should max out that amount when you buy your home.
“I generally don’t recommend using PMI to buy a larger home that will stretch your finances, as any hitch in your life can make your mortgage harder to pay and cause a lot of stress,” says Stanley Himeno-Okamoto , founder of DRS Financial Partners.
A smarter approach for a first-time homebuyer might be to buy a “starter home,” a less expensive home that they can easily afford without paying PMI.
Ask the Experts: When Does PMI Make Sense?
We asked financial professionals in the Wealthtender community to offer their insights on private mortgage insurance. Read their comments below for tips on when PMI might make sense for homebuyers, plus additional ideas for avoiding PMI.
Eric Simonson, CFP®, CRPC®, CLTC® Flat fee Financial planning for all of life’s adventures Read more
Stanley Himeno-Okamoto, CFA, CFP® Helping tech professionals make smart decisions with their stock compensation. read more
Kelley Long, CPA/PFS, CFP® Find Your Financial Bliss™ Read more
David Creekmore, MBA Helping those who help others Read More
One last thought…
Perhaps the most obvious solution to the PMI dilemma is to reconsider buying a home until you can put down 20%, thus avoiding PMI entirely. While this may delay your dreams of owning your own home for some time, it may also give you an opportunity to step back and consider whether now is really the best time for you to take on the responsibility and expense. of home ownership.
If you wait until you have saved 20%, you will be in a stronger financial position to negotiate better terms with lenders. It also gives you the opportunity to carefully weigh all your options before making one of the most important purchases of your life.
Are you ready to enjoy life more with less money stress?
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About the author
Elizabeth Blessing
I am an editorial writer and copywriter for financial and investment publishing houses.
I’ve written about growth investing for the award-winning newsletter, The Complete Investor, and about high-yield stocks for Leeb Income Millionaire and Leeb Income Performance.
This post 5 Ways to Avoid Paying for Private Mortgage Insurance (PMI)
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