The Pros and Cons of PMI
Ever heard of a little thing called PMI? It’s a few letters that can have a big impact on the way you buy your home, take out a home loan, and pay your mortgage each month. Let’s look at the pros and cons of PMI.
First thing’s first: you need to understand what PMI is and why it may apply to your mortgage. It stands for private mortgage insurance, and you pay it monthly with your regular mortgage payment.
But it’s not quite like other insurance policies you pay for. With homeowner’s insurance, for example, you take out a policy to protect you and your property should anything happen (like damage to your home).
PMI is designed to protect the lender who underwrote your mortgage. It protects them in case you default on the loan and fail to pay the remaining balance and interest fees.
Even though the lender takes out the policy and the insurance covers their investment in your property, you as the mortgage borrower must pay the monthly premium.
PMI Can Be Useful to Homeowners
While that sounds like a raw deal, PMI isn’t always bad for you. Lenders expect average homebuyers to put down 20% of the value of the home they want to purchase in cash in order to get a mortgage. The lender then originates a loan for the other 80% of the cost of the property.
But a 20% down payment is a serious chunk of change. On a house that costs $250,000, that’s $50,000. For a $500,000 house, you need to put down $100,000 in cash to reach a 20% down payment.
That’s a big burden to place on anyone, and you may not be able to buy if you have to come up with 20% in cash for a down payment. (And remember, that’s on top of all the other expenses you need to pay in cash upfront when you buy, including closing costs and any immediate home repairs.)
Lenders may still approve you for a mortgage if you have less than a 20% down payment. 10% is a reasonable number. You can even qualify for some loans with as little as 3%.
This may allow you to purchase sooner. But there’s a tradeoff: the lender will require PMI on your loan and you’ll need to pay the monthly premium associated with that.
This is where PMI isn’t always bad. It gives you the flexibility to put less down on your home in cash and potentially buy sooner. And depending on how much PMI will be on your mortgage, that monthly fee may be worth the cost.
Are There Benefits to Putting Down Less?
That’s because putting down less in cash upfront can sometimes benefit you. While you’ll have less equity in your home, you’ll also have less of your liquid assets tied up in your new, illiquid investment.
Your home may be a smart buy, but you can’t get your cash back out of the property or realize the gains if your house rises in value until you sell. If you keep your cash with you, on the other hand, you can use it to achieve other financial goals or invest in places where you can get quicker, larger returns.
There’s no guarantee with any investment, of course, but keeping more cash on hand gives you more flexibility and choice to take advantage of opportunities as they come up. You may not be able to invest in other areas if you tied up all your cash in a huge down payment on your home.
Plus, accepting the tradeoff of PMI in order to put down less on your mortgage isn’t necessarily a permanent one. PMI can typically be cancelled once your loan-to-value ratio drops to 80%.
Always follow up with your lender if you have PMI and believe it should be removed. It is not automatically cancelled.
Where PMI Can Cost You
On the other hand, private mortgage insurance is not always the right choice. PMI is a fee you don’t necessarily need to pay — simply put down a larger amount in cash upfront, and the lender won’t require it.
Also, while mortgage interest is deductible on your income tax return, PMI may not be.
Nor does it provide any benefit or protection to you (or your heirs, like some other insurance policies). Remember, this coverage protects the lender in case a borrower defaults.
Bottom line, you’re paying more each month for your mortgage if it includes PMI. The cost can range anywhere from half a percent to 1.5% of your loan amount annually. If you borrowed $300,000 for your mortgage and your PMI amounts to 1% of that, you’ll pay $3,000 a year for the premiums — or $250 per month. Over a number of years that can really add up, which is why some people choose to avoid paying PMI.
For those who don’t want to pay PMI, there is another alternative to consider. Unison can match your down payment cash by making an investment in your property, through the Unison HomeBuyer program. If you have 10% to put down, Unison can make it 20%. With a full 20% down payment you won’t need PMI. And since the money from Unison is an equity investment, and not a loan, you don’t pay interest or make monthly payments to Unison. This can lower your monthly payment considerably versus a 90% loan with PMI. In exchange for providing a portion of your down payment, Unison will share in the change in value of your home when you decide to sell, up to 30 years later. If your home’s value rises, Unison will make a profit, and if its value falls, Unison will share part of the loss too.
Each individual buyer will need to determine if the cost of PMI makes sense for their financial situation, and consider other solutions. There are always pros and cons, so look at all the factors and evaluate the possibilities before making a final decision.