Private mortgage insurance (often referred to as PMI) is one of the necessary evils for individuals trying to buy a home with a down payment under 20%.
How it works:
First time home buyers often get confused between homeowner’s insurance and mortgage insurance. Homeowner’s insurance is a property insurance that protects you financially if your property is damaged as a result of a natural disaster or accident. It is coverage that protects you as the homeowner.
PMI does not protect or benefit you, it protects the bank… but you pay for it. Nice, right?
PMI is required when you purchase a home with less than a 20% down payment. This protects the bank in the case that the home is foreclosed on as the insurance will kick in to help cover the losses the bank experiences in foreclosure.
Why is PMI Necessary?
Banks typically like to have at least a 20% downpayment when an individual purchase a home. This is the number widely recognized by the industry to show that the home is affordable by the individual purchasing. If you can’t afford the 20% downpayment, in the eyes of the bank, you are automatically a riskier buyer on paper than someone who has saved up 20%.
PMI is necessary because it is the bank’s way of feeling comfortable giving a riskier buyer such a large loan without a significant downpayment.
Will I need mortgage insurance?
If you are planning on purchasing a home, and you have less than 20% of the home’s value to put as a down payment, you will likely be required to purchase PMI.
Zillow says my house is worth $300,000, and I only owe $210,000, can I get my bank to remove PMI?
Getting rid of PMI is trickier than it sounds. And, no, unfortunately your bank will not accept a Zillow estimate as an actual appraisal.
That said, here are some ways to get rid of PMI insurance:
1) Pay off 22% of the original home value — If you pay down your principle to 78% of what your original appraisal showed the house to be worth, at that point, federal law states that lenders are required to remove PMI. Notice, we didn’t say 78% of the purchase price. The purchase price and original appraisal value are of course not the same thing. Dig through those old closing documents and pull out that original appraisal.Then compare it to your current payoff amount on your home to see where you are at.
2) Request it from the bank once you pay off 20% of the original home value — While banks are not required to remove PMI until you’ve paid off 22%, they might. Contact your lender and see if they will remove it. Bank policies differ on this so be sure to check.
3) Order a new appraisal — If you think your house has appreciated in value to the point where you now have more than 20% equity, have your bank order a new appraisal for you. This is actually where tools like Zillow can help. Even though a Zillow estimate is not official, it can be used to give you a ballpark value of your home.
4) Pay down the principal — You don’t have to wait until your regularly scheduled mortgage payments to bring the balance down. You can pay down the principal with your current savings. Be sure to check with your advisor to be sure that is the best use of your savings.
5) Refinance — Refinancing comes with costs. But doing so might be advantageous in the long run as it means a new bank, new interest rates, new appraisal which could mean no PMI. Refinancing isn’t cheap, so be sure you are doing so at the right time and that it is truly saving you money in the long run. Refinancing is probably not a good idea if you are not planning on owning the home for at least the next 5 years.
Financial planning opportunity:
With any major cost in life, you also have opportunities. PMI may add up over time, but it doesn’t mean you need to avoid it completely. Some people are so averse to the cost of PMI that they avoid a home purchase altogether. This isn’t necessarily financially savvy as we are currently in a housing market environment where renting is more expensive than owning in most areas — even with the PMI. This is especially true when you consider opportunity costs of renting and standard of living.
It is always best to sit down with your advisor, talk over your desired lifestyle and make a smart choice for you and your family.