Private mortgage insurance is a requirement for many borrowers who fail to meet the minimum 20 percent down payment requirement. While it is often misunderstood, private mortgage insurance is not necessarily a bad financial move. This article is going to teach you about private mortgage insurance. We will also cover 6 pros and cons of having it on your mortgage.
What Is Private Mortgage Insurance?
Private mortgage insurance is simply put a financial product. It often comes up as a requirement for borrowers who fail to make at least a 20 percent down payment on their mortgage. Private mortgage insurance, also known as PMI for short, is designed to protect lenders. Their main threats are increased risks of making loans to borrowers with lower down payments.
Unlike most insurance policies, PMI does not pay out to your loved ones in the event of your death or incapacitation. Instead, the lender receives a payment to help them recoup some of the losses related to any failed mortgage payments.
The majority of PMI payments are billed monthly and are made in addition to your mortgage payments. The exact amount will vary based on the size of your loan amount. For a $100,000 mortgage, the average PMI payment can range anywhere from $42 to $84 a month.
In most cases, PMI must be carried unto your LTV, otherwise known as loan to value ratio, dips below 80 percent. You will know your home meets this requirement when you have established at least a 20 percent equity value in your home. This typically occurs as your home value continues to rise and you slowly pay down the principal balance of the loan.
The Pros of Private Mortgage Insurance
Take Advantage of Rising Home Values
One of the biggest advantages of private mortgage insurance is that it allows many homeowners the opportunity to take advantage of rising home values. Let’s say you only have enough to make a ten percent down payment on a home. To save up an additional ten percent, you may have to save for as much as an additional six months to a year.
Instead, you could opt for purchasing a home during rising prices and take advantage of increased equity growth. If things continue, you could be well on your way to building more than 20 percent equity in your home and canceling your PMI early.
Lock in Low Interest Rates
Another distinct advantage of private mortgage insurance is that it allows users to lock in low-interest rates much sooner. Similar to the above example, prospective home buyers can purchase a home with down payments ranging from three to ten percent.
If you opted to save up until you had at least a 20 percent down payment, it’s entirely possible to experience a rate increase as high as one percent. This is particularly true during economic times where the federal reserve is looking into new policy changes. This translates to increased costs over the entire life of your loan. Not only does this cost you more in the long run, vut it also makes it more difficult to pay your loan off early.
Consolidate Your High-Interest Debts
Another major pro for opting for private mortgage insurance is that it allows you to consolidate your high-interest debts. Let’s say that you have enough money saved up to make a full 20 percent down payment on a home.
You can consider making the full 20 percent payment. However, you can also make ten percent and use he remainder to pay off your most expensive monthly debts. You can reduce your total monthly payments and use the difference that you save to make additional principal payments on your mortgage. With these additional principal payments, you can likely have the private mortgage insurance removed much sooner than usual.
The Cons of Private Mortgage Insurance
Can Be Costly
One of the biggest cons of private mortgage insurance is that it can prove to be quite costly. The average cost of private mortgage insurance ranges anywhere from 0.5 percent to one percent of your total loan amount on an annual basis. However, it is possible to find slightly lower options. Nonetheless, he price range above is fairly standard among the majority of private mortgage insurance providers.
For a $100,000 mortgage, this translates to an additional $1,000 per year. Unfortunately, this money is completely lost and doesn’t benefit your family in the long-term. This is why it is strongly recommended to get private mortgage insurance removed from your loan as soon as possible.
Facing the Difficulties of Removal
While lenders are very quick to add private mortgage insurance to loans, they are not so quick about removing it. Unfortunately, private mortgage insurance is not typically removed from your mortgage as soon as you fall below the 80 percent loan to value ratio. Instead, most mortgage providers require their customers to submit requests for PMI cancellations via an official letter.
Once the request is received, many companies require an official appraisal to be ordered as well. The cost for an appraisal varies significantly with most averaging anywhere from $400 to $600. Unfortunately, the borrower is often responsible for this cost. In the event home values have lowered in your area, you can find that your request for PMI cancellation is denied.
Beware of Non-Cancellation Clauses
With most companies, the standard procedure is to allow for cancellation. However, this can happen once your loan to value ratio has dipped below the 80 percent mark. Unfortunately, there are a select few who may choose to mandate that you carry your PMI coverage for a specific number of years as part of your contract.
Pay careful attention to the disclosures from your mortgage company and PMI provider. Make sure that you do not fall into one of these traps. These types of agreements are harmful to you as the borrower and should be avoided at all costs. If you’re able, consider negotiating with your mortgage provider before closing to have these types of clauses removed.
As you can see from our list of pros and cons, private mortgage insurance is a bit of a mixed bag. When deciding if you should opt for a mortgage with it, you should take a broader look at your overall financial picture. Consider both your short-term and long-term goals. By doing this, you can help ensure that you make the best financial decision possible for you and your family.