If you’re purchasing or refinancing a house with less than 20% Equity. You’re going to be subject to having PMI. Here’s what you need to know regarding private mortgage insurance with regards to financing your house…
When you have less than 20% equity on your house the mortgage company is going to require you to have private mortgage insurance which Insures the loan if you default on your mortgage. To get the lowest cost of PMI the magic number generally is 15% equity and a credit score greater than 740. Obtaining private mortgage insurance is available if you don’t have these numbers however the costs can change. Following is the three types of PMI and how they might benefit you when buying or refinancing a house…
Monthly PMI this is the most common type of mortgage insurance as it is the simplest to compute. It’s usually based on anywhere between .5 to 1% of your loan amount on an annual basis.
Advantages: you can discharge the PMI after 20% equity by calling up your lender and petitioning the removal. It will be up to your individual lender to allow the monthly PMI to be removed.
Disadvantages: The lender may not let you out of the pmi 20% equity forcing you to refinance to drop the pmi while taking a market interest rate. The lender must remove the PMI at 22% Equity of the original value at original application based on an amortization schedule. This is generally about 120 months for this to take place.
Single pay mortgage insurance this allows you to essentially pre-fund the PMI without having monthly PMI. You don’t have to refinance and you never have to worry about discharging the PMI with your current lender.
Advantages: monthly mortgage payments are significantly lower with no monthly PMI.
Disadvantages: it is prepaid so these is no refund or discharge ability in the future.
Split pay mortgage insurance means you can finance half of the mortgage insurance and then cash finance the other difference or you can finance half of the mortgage insurance and then elect to take a monthly pmi premium. Either way this allows you to have a little bit more flexibility with your cash and your monthly payment.
Advantages: lower monthly payment which means lower debt to income ratio increasing borrowing power
Disadvantages: you’re still paying a portion of that PMI and you can’t discharge any of the PMI.
To be clear you cannot discharge the PMI on single pay mortgage insurance or on split pay mortgage insurance. The only pmi options that will allow you to discharge the PMI is electing to take the full monthly amount. Having a lower monthly mortgage insurance premium means your debt to income ratio is going to be lower. Put another way what you give up in future borrowing a power is retained with cash if you elect to do the monthly PMI.
Whenever you are buying a house or refinancing a house and you have less than 20% equity to work with you will come into one of these situations with regards to PMI. There is another alternative which is lender paid mortgage insurance however that also contains a higher interest rate usually more than a market rate. This higher rate offsets the benefit in most cases.
Let’s say for example you’re looking at a 30-year mortgage at 4.75% on a 30-year fixed rate and monthly PMI at $300 per month. It would be reasonable to expect to take on an interest rate somewhere around 5.625% to have lender paid PMI. Based on your size of a loan that could very easily offset $300 a month which negates the benefit especially when considering how much interest expense you will pay over the total term of the loan.
If you’re looking to get a mortgage consider all your options and weight them against your short and long-term housing plans.
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