What to Know About PMI
Private Mortgage Insurance (PMI) is a way for lenders to protect themselves from a mortgage default. It's usually required of homeowners who can't produce a 20% down payment on their property. Learn more about what PMI actually does and how homeowners can safeguard themselves from paying unnecessary fees.
The Reality of PMI
When buyers first start looking for a property, they're likely to see any number of enticing claims. For example, they may see that all they need to purchase a home is 3.5% of the property value for certain types of mortgages. However, as tempting as this may be, there's a catch to starting with the lowest possible down payment. This is because lenders are taking a big risk when they approve someone for a loan. A homeowner who defaults may surrender the property to the lender, but the lender still has to offload the property to another buyer.
PMI is a type of insurance policy for lenders in case this occurs, but it's not the lender who pays for the premium. Instead, the homeowner pays the premium and the lender uses that money to pay for the policy.
PMI is a policy that covers the costs of advertising the property, setting up an auction for it, and any number of incidental costs that spring up along the way. Lenders depend on it as a way to keep themselves from being saddled with too many expenses in the event of mortgage default.
What PMI Does
PMI was created as a way to encourage homeowners to save as much as possible for a down payment. It essentially penalizes those who are most likely to default on their home. If PMI didn't exist, the lenders would have to spread the costs of foreclosed homes over every lender.
PMI typically disappears when homeowners reach 20% equity in their homes. While someone with 25% or even 95% equity could still potentially default on their mortgage, the theory is that they're less likely to do so after investing so much time and effort into the property.
How Much is PMI?
PMI typically costs about .5 – 1% of the cost of the property per year, which is a sizeable figure for buyers with a higher-end property. Because that's a per-year charge, owners are encouraged to pay off as much as possible from the minute they buy the property. This will not only cut down on the rate of interest the owner has to pay, but they can also get rid of PMI that much faster.
Here are a few additional tips for home buyers:
- Lenders: Homeowners should be asking questions about PMI to their lenders, including how much it is, how the policy will be canceled, and what the payment options are.
- Refunds: Some homeowners may need to vacate their home much sooner than expected. It's worth finding out more about the lender's refund policy just in case.
It's unrealistic to expect every homeowner to come up with 20% of the price of a property, especially in areas that are highly in demand. However, homeowners should be trying to avoid these extra costs whenever possible. The best thing that can be done is to work with a lender who will honor their commitments and set homeowners up for success.