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By Kathryn Pins
Owning a home is a wonderful experience but purchasing a home can sometimes be stressful. Don’t worry though! I’m here to help because purchasing a home should be just as great as owning a home. I had many questions when picking out a lender and a mortgage. Among those questions were what is private mortgage insurance and do I need it? Here is what you need to know.
Private mortgage insurance or PMI is a type of mortgage insurance that protects the lender if you stop making payments on your home loan. It creates less risk for the lender because it ensures that they will get paid if you default on your loan or if you are unable to pay your mortgage. It’s required by some mortgage lenders if you don’t put 20 percent down on a home purchase.
There are two types of mortgage insurance: government and private. The government insurer is called the Federal Housing Administration. We will be discussing private mortgage insurance.
There isn’t an exact number to this question because a lot depends on the type of private mortgage insurance you have. Each type requires that you have paid 22 percent of the home’s purchase price before your PMI is canceled. This number is calculated using the mortgage’s loan to value (LTV) ratio.
There are three types of private mortgage insurance:
When calculating how long you will need PMI, take a look at how long it will take for you to reach 22 percent equity and the type of mortgage insurance you will be using. In short, read the fine print so you know your options.
PMI fees vary depending on the size of the loan and how much you are putting down. You will typically see that the lower your down payment, the higher your PMI rate. Private mortgage insurance can cost between 0.25 percent and 2 percent of the entire loan on an annual basis.
Let’s break this down: Say your loan is for $200,000. One percent of that loan is $2,000 a year. Your monthly PMI payment will be $166.66. If it takes you five years for you to reach 22 percent, then you will pay $10,000 toward your PMI.
You will not see your equity grow by paying this insurance. You are giving your money away and will not see any return on those dollars.
There are two reasons why you may be required to get private mortgage insurance. The first reason depends on your lender. The second depends on how much you put down. Many lenders require PMI if you put less than 20 percent down because the loan is viewed as a bigger risk. However, other lenders have programs that do not require PMI if you put less than 20 percent down. For example, the Alliant Advantage Mortgage (AAM) program allows first-time homebuyers to put down 0 percent with no PMI payments. The same program also enables non-first-time homebuyers to buy a new home with 5 percent down with no PMI. The moral of the story: when comparing mortgage lenders, check to see if they require private mortgage insurance if you haven’t saved for a big down payment.
Kathryn Pins is a marketing content specialist at Alliant. She’s passionate about finding and communicating meaningful financial information with Money Mentor readers. Kathryn is a saver who gets more excited about certificates and her Roth IRA than shopping. When she does spend her earnings, it’s on furthering her education, travel, unique experiences, and loved ones.