Private Mortgage Insurance (PMI): A Waste of Money or a Stepping Stone to Homeownership?

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It might sound impossible given the red-hot real estate market over the past two years, but homes are expected to get even more expensive in 2022.

Home values will rise another 11% this year, according to a Zillow forecast, putting even more strain on the budgets of prospective homeowners. That means it will become even more important to understand, and potentially reduce, all of the costs involved with buying a house.

One of those costs could be private mortgage insurance. Known as PMI, this is a fee your lender could charge you depending on the size of your down payment. PMI increases your monthly mortgage payments, so before you lock down a loan you should make sure you understand what PMI is, how much you’ll be charged, and if it’s worth the cost.

How Much Does Private Mortgage Insurance (PMI) Cost?

When a borrower has less than 20% for a down payment, in the eyes of the lender they become at greater risk of defaulting on the loan. Private mortgage insurance (PMI) is all about protecting the lender from that risk.

“It’s insurance that’s covering the lender’s risk if you can’t afford to put down 20% on the property,” says Vicki Ide, vice president and residential lending manager at Tompkins VIST Bank in Pennsylvania.

Lenders add PMI to your mortgage in exchange for accepting the higher risk of a smaller down payment. The extra fee acts as insurance for the lender in the event that you couldn’t afford to keep making payments on the mortgage.

The cost of PMI will depend on a few factors, including the size of the loan and your credit score. Paid either monthly or in a lump sum upfront, typically, you can expect PMI to cost between 0.58% to 1.86% of the loan amount according to mortgage insurance data from the Urban Institute. In dollars, Freddie Mac estimates this to look like $30 to$70 per $100,000 added to a monthly mortgage payment. “If you’re borrowing more, they’re going to charge you more,” says Michelle Petrowski, a certified financial planner in Phoenix. Here’s an example of how that cost would breakdown: On a$300,000, home with a 30-year fixed rate mortgage:

In this example above, the loan with the 5% down payment required PMI. Based on a credit score between 700-719, this example borrower could expect to pay 0.99% of their loan amount: $2,821.5. If you divide this figure by 12, you will get the monthly PMI payment of$235. The total cost of PMI will reach \$21,983 when the borrower reaches 20% equity in the home and PMI payments conclude.

Pro Tip

Remember that PMI doesn’t last forever: It can be removed after you reach 20% equity in your home.

Factors That Affect PMI

The amount of PMI you pay will vary by lender, but also depends on your personal financial profile.

But credit score is not the only metric that changes PMI: It also takes into account the size of the loan, the size of your down payment, and the type of mortgage.

“It’s going to be individualized,” Ide says. Make sure you understand how each of these factors impacts PMI so that you can make an informed decision about the cost before taking out a mortgage.

Down payment amount:

Your down payment is the key factor that determines whether you will pay PMI at all. If you put down 20% or more on your home purchase, you will not have to pay any PMI. If you put down less than 20%, however, you can usually expect PMI.

Ide says the most important thing here is loan-to-value ratio. For example, if you put down 15% on your purchase, that’s an 85-15 ratio (meaning 85% mortgage, 15% down payment). That scenario might leave you paying less PMI than a 95-5 ratio (meaning 95% mortgage, 5% down payment).

Size of loan:

The size of the loan is one of the biggest factors that impacts PMI. That’s because the more money you borrow, the riskier it is for the lender in the event you ever stopped paying.

Petrowski says that each lender is going to have slightly different brackets for PMI based on loan size, but generally speaking, if you borrow more, you can expect to pay more.

Credit score:

“The better your credit score, the better your [PMI] rate is going to be,” says Ide.

Your credit score is an important metric for any type of financial transaction. It tells the lender how reliable you’ve been in the past, and how risky you will be as a borrower.

A better credit score will usually mean lower PMI payments, according to Ide and Petrowski. For example, a credit score of 750 would likely put your PMI toward the lower range of 0.58%; a lower credit score of 600 might bump the cost more toward 1.86%, the higher end of the range.

But again, every lender will calculate the cost slightly differently, says Ide and Petrowski.

Type of mortgage:

Private mortgage insurance is generally cheapest with conventional 30-year mortgages, Ide says. Mortgage insurance can be higher with government-backed loans, such as FHA or USDA mortgages, where the rates are set by the government.

Borrowers with lower credit scores can often be approved for government loans when they don’t qualify for private loans, which is another reason government loans can have higher PMI.

“If you’re more in that type of position, your money is a little tight and your score is not that great, that’s why more people lean more toward FHA loans,” says Ide.

PMI can also be higher on jumbo or construction loans, Ide says, again because the risk of those mortgages tends to be higher.

Should I Avoid Private Mortgage Insurance?

Private mortgage insurance is a heated topic of debate in the world of personal finance. On one hand, accepting PMI allows you to move into a home with a lower, more accessible down payment. But on the other hand, it increases your monthly mortgage payment.

“People think it’s a waste of payment, and the extra they’re paying monthly is doing nothing for them,” says Ide. This argument suggests PMI only helps the lender while increasing costs for the borrower.

However, PMI can open up access to homeownership for people who don’t have a 20% down payment. And once a homeowner gets into a property, there’s always the possibility of refinancing down the line, renting out a room in the home to earn passive income, or upgrading the house and making a great return on investment when they sell the home at a later date. Each situation is nuanced and specific to the individual, but some look at PMI as simply a cost that brings greater good.

PMI is therefore a good tool to have, says Ide: “It makes some properties more affordable, and I don’t think it’s that expensive for what it is.”

Additionally, PMI doesn’t last forever, according to Petrowski. It can be removed once you pay enough of the mortgage that you have at least 20% equity in the home.

“I don’t think it’s necessarily the dirty little secret you have to avoid,” Petrowski says. It all comes down to what you care about most. If your goal is to own a home sooner rather than later, PMI might simply be one option to do so. For people who care strictly about the numbers, choosing PMI might not make sense because it makes homes more expensive in the long run.

“If you’re really close to saving the 20%, maybe it’s worth it to just wait a little bit longer and save up that extra money,” Petrowski says.

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