Mortgage Insurance is often a necessary expense that borrowers must incur if they don’t have the standard 20 percent down payment amount. Mortgage lenders will require a private mortgage insurance (PMI) as a result of the lower down payment. Choosing to pay the insurance yourself or opting to allow the lender to pay it depends on how long you plan to stay in the home and whether or not you are in a moderately appreciating real estate market.
PMI is a policy that protects the bank if you default on your loan. People like to think of anything with the word “insurance” in it as being something that gives us comfort should an event happen, but it really isn’t the case here. You pay for the policy as the homeowner, and it protects your bank should you stop making mortgage payments. There are two main types of mortgage insurance; borrower-paid and lender-paid, both having pros and cons.
Borrower-Paid Mortgage Insurance:
If you elect to pay the mortgage insurance on your own the lender charges a yearly premium paid in monthly installments. On average, the premium costs between .44 and 1.15 percent of the total loan amount. For example, if your mortgage loan’s total is $200,000, the yearly premium at .64 would equal $1,280 or $106.67 per month. The borrower-paid mortgage insurance can be cancelled once you’ve paid down the loan balance to below 78 percent of the original loan to value ratio with just a request to the lender. If you would like to try and remove the PMI prior to the scheduled payment pay down method, you would need to request (and pay for) an appraisal from the lender to see if the value is high enough to remove it.
Lender-Paid Mortgage Insurance:
Some lenders might be willing to pay the PMI premiums for you, however it will still come at a cost. In exchange for payment of the PMI, the lender will charge you a higher interest rate, that will need to be paid over the entire life of the loan. The lender-paid PMI will never be cancelled, because it was calculated into the fixed rate. In order to eliminate this, the loan must be refinanced into a lower interest rate loan.
In general, there are characteristics of a loan that would suggest lender-paid mortgage insurance may make more sense if:
· You are likely to move or refinance within 10 years – The payment will be lower and the interest rate difference will not be as impactful over a short period of time.
· You have less than 10-15 percent to put down – Assuming the real market does not appreciate well, it will take many years to reach 78 percent loan to value.
· There is a preference of a lower mortgage payment – Eliminating monthly PMI does typically yield a lower payment.
· There is a potential for a larger tax deduction - Since mortgage interest can be tax deductible and PMI cannot, you could conceivably agree that the higher interest rate would equal a larger deduction.
These types of situations would suggest that borrower-paid mortgage insurance would be a better option:
· If you plan to remain in the home 10 years or more – The longer you have the loan, the more beneficial a lower interest rate will come into play.
· If you have a higher down payment than the minimum required – The goal is to get your loan to value ratio at 80 percent. If you have more down payment up front, the monthly PMI should in theory drop off sooner
· Expect an increase in home value
Most borrowers do opt for borrower-paid mortgage insurance in general but these are all things to consider when making this very important decision. Your credit score and overall financial profile may also help with which option is best. The most important thing to note is that you have a very educational and specific conversation with your mortgage professional as every person’s situation is very different.