One of the dreaded things of the housing and mortgage industry is an additional expense called private mortgage insurance that’s added to your monthly mortgage payment. PMI should be avoided by whatever means necessary. However, perception is everything so let’s talk about and break down what PMI is and is it as bad as what the Internet would have you believe?
Private mortgage insurance is something that lenders will assess on your mortgage when you’re buying or refinancing a house with less than 20% down. Think of it as foreclosure insurance if you don’t make the house payment. The mortgage is insured against payment default that’s effectively what it is. Depending on the type of loan that you have, the PMI may or may not be dischargeable in the future and it’s not necessarily as ugly as everyone may think it is.
Here is private mortgage insurance as it relates to conventional mortgages on a conventional mortgage loan. PMI is either assessed in 1 of 2 ways, either monthly or up front. Yes, there’s an upfront option that most lenders don’t talk about because it requires them to do more work. Make sure to ask the lender that you’re working with if they offer such an option. If they don’t, dump them and find one that does. Most reputable mortgage companies have monthly mortgage insurance and upfront mortgage insurance as options depending on your credit score loan to value.
The PMI on a conventional mortgage can be based monthly. It’s anywhere from $80 to $100 per $100,000 per month. For example, you might be looking on a $300,000 loan with PMI at somewhere around $300 per month. Which can be a lot of money, $50,000 translates to about $50,000 of spending power. It can add up from a buying power from a real estate negotiation perspective. The PMI on a conventional mortgage can also be discharged. Here is where things can get a little bit murky. In order to get rid of the PMI, most mortgage companies require you to have the PMI on the mortgage for a set period, typically 24 months. You can discharge the PMI if the individual service or i.e., the company that you’re making your mortgage payment with will allow you to do it in say 12 to 24 months with 20% equity. That’s provided the value has not dropped below the purchase price or the appraised value at the original time of application and obviously your current on your mortgage. Those are generally the elements that the bank needs but, the bank is under no obligation to remove the PMI. The PMI automatically is removed at 80% of the loan value of the original application. Based on a payment ambition schedule not only by market forces, paying down your mortgage, and not doing something else creative. On an advertising 30-year fixed rate mortgage for most families that 80% loan to value mark typically pencils out to somewhere around 8 to 10 years which is a very long time for automatic PMI removal by the bank.
The better your credit score is the lower the PMI is. You’re hearing that right. So, if your credit score is excellent, you can anticipate very low PMI. If your credit score needs a little bit of love, then the PMI might be a little bit higher. You can always refinance the mortgage if the lender will not let you out of the monthly PMI. This is something to keep in mind as interest rates are particularly favorable and likely will remain that way.
PMI as it relates to FHA loans is a little bit more challenging. There’s an upfront mortgage insurance premium at 1.75% of the loan amount, then there’s a monthly version as well. The benefit of an FHA loan is that it will absolutely increase your borrowing power and it will give you more of a fighting competitive chance to get your offer into contract if you need to push the envelope in terms of spending power. The FHA loan also allows 3.5% down. Think of it like this, you must have PMI in exchange for doing an ultra-low-down payment at 3.5%. Yes, you can refinance out of the loan in the future. That’s not a horrible trade off depending on your income, cash, credit, and the market in which you’re looking to purchase a home.
The PMI on FHA loans with less than 10% down is permanent and the only way out of it is to sell the house or to refinance the house. That doesn’t mean automatically work towards getting a conventional loan because you could get an FHA loan and then refinance into a conventional loan anyway. For a lot of people that’s just not an option as the market is evolving and changing at a much faster rate than their ability to work on their credit score. For example, to go into a conventional loan FHA is way more flexible as it pertains to credit scores than conventional is.
So, what loan do you go with? Should PMI be something to avoid all costs? No, because the type of cash that it’s going to take to avoid PMI in its entirety is significant. So, if you have a good credit score and your PMI is something like $80 a month based on your amount financed. Or the idea of paying PMI just bothers you to your core but you don’t have 20% down, maybe you have say 12% down, is it worth giving up a house that you know you can afford because of that $80 month payment benefit? To get around that by coming up with an additional $70,000 or $80,000 of cash? That’s a tall order and doesn’t make sense. That’s what’s called chasing over dollars to get dimes. $80,000 of cash to get rid of $80 a month of PMI doesn’t make sense. Take the loan with the PMI and work with the lender to discharge the PMI in the future. So, it’s a bottom line if you can afford the house payment and you’re feeling optimistic about your income, your liabilities, and your monthly budget as relates to having a life focus. Don’t worry so much about the cost of the PMI which might be a necessary evil to help you and your family accomplish your long-term financial objective.
All 3 elements must be in place to buy a home. It’s sort of like baking cookies in a way. If you use too much sugar or too much flour the cookies are going to come out tasting not quite as good right? It’s the perfect blend of having cash, credit, and income. All 3 elements are what will help catapult you from where you are presently, to where you’re desiring to go in the future. A good real estate agent and lender can help walk you through these steps and help create for you a long-term home buying plan if you’re not ready right now. Most people are not ready right now, but it’s the plan and the look ahead to the future that really is the separating factor between the goal and an actual reality.
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