Purchasing a home is an investment that can pay many personal dividends. Not only does it give you a sense of pride, it provides you with the opportunity to create a place that’s uniquely yours.
One of the biggest hurdles prospective buyers face is saving money for the down payment. While the days of being able to buy a home with no money down may be history, there are still many “Conventional” loan programs that require as little as 3% down (a Conventional loan meets the qualifying guidelines of Fannie Mae and Freddie Mac, the two biggest agencies that buy mortgages from lenders in the U.S.).
Lenders generally require Private Mortgage Insurance (PMI) when someone puts less than 20% down. PMI partially protects the lender against potential loan default in the event the home goes into foreclosure. It does not offer protection to the homeowner in the event of a death or disability.
The biggest advantage of PMI is that it may let you buy a home now instead of waiting to save for a larger down payment. With home values being more affordable than ever and interest rates at historic lows, PMI may allow you to move into the home of your dreams sooner than you thought possible.
The “private” in PMI just means the insurance is available in the private marketplace. This differs from other types of default protection for lenders that’s offered under government sponsored loan programs through the Federal Housing Administration (FHA) and Veteran’s Administration (VA).
After applying for a mortgage, your lender will determine how much the PMI premium will cost based on your down payment amount, credit score, loan program and other factors.
The PMI policy is obtained directly by the lender prior to closing on your new home from one of their approved PMI companies. The rates are generally competitive among the various insurers; however, borrowers aren’t able to pick the company themselves.
There are several payment options for PMI. Most borrowers decide to include the premium with their monthly mortgage payment. It can also be paid in a single one-time payment at closing, or even a combination of a lump-sum amount with a smaller monthly payment. There may be advantages to each payment option based on each person’s financial situation.
Here’s an example of how monthly PMI works.
Let’s say you have a good credit history and buy a $400,000 home with 5% down. In this case, PMI would cost about $212 a month. With 10% down, the PMI drops to about $147 a month. While this may seem like a lot, it may make the difference between being able to buy a home now or waiting until you have a larger down payment. By then, home prices and/or interest rates may have gone up.
One final note, PMI is different from other types of insurance that are related to buying a home. For example, hazard insurance protects you and the lender is the event there’s a fire or other damage/loss to the home. Flood and/or hurricane coverage may also be required in certain geographic regions. Make sure to talk to a real estate agent in advance so you can understand what type of insurance you may need.