What Is PMI and Should You Avoid It?

When it comes to buying a home, there are a lot of terms to learn. HOA, ARM, APR, PMI…it quickly turns into alphabet soup. Before you know it, you’re left scrambling to understand what comes next. One of the most confusing terms you’ll come across is PMI or Private Mortgage Insurance.

 

What exactly is private mortgage insurance? Should you avoid it? Is it even possible to avoid PMI when buying a home? In this guide, we’ll break down exactly what PMI is and why it matters when you’re buying a home. In addition, we’ll cover whether or not you should avoid it when the time comes to apply for your mortgage.

 

 

What Is Private Mortgage Insurance?

First, let’s breakdown what exactly PMI is. As we said earlier, this is an abbreviation for Private Mortgage Insurance. Basically, it’s a way to make sure your lender is protected in case you default on your mortgage and the home goes into foreclosure.

 

When you apply for a home loan, most lenders require a 20% down payment. Because many lenders today aren’t able to afford such a large downpayment, lenders require borrowers to take out an additional insurance plan.

 

PMI is like an insurance plan for your mortgage. Your PMI will be paid monthly as part of your overall mortgage payment to your home loan lender. Your PMI will likely cost between 0.5% and 1% of your entire mortgage loan annually. That can add up really fast!

 

How Long Do You Pay PMI?

You might now be asking how long you’ll need to pay PMI. What happens when you surpass that 20% payment on your home through your monthly payments? Do you still have to pay private mortgage insurance on the loan?

 

In short, no. Once your loan balance is scheduled to reach 78% of the original value of the home (aka when the equity reaches 22%, the lender is required to terminate your PMI. In addition, if you’ve paid enough towards your principal amount of the loan up to a 20% down payment, you can request the PMI payment be removed. While PMI is costly, it is only a temporary part of the home buying process.

 

Should You Avoid PMI?

Finally, should you avoid paying PMI? As we said before, PMI comes at a high cost. It could potentially cost you up to 1% of your entire mortgage loan amount annually. If you have a $200,000 loan, you’ll be paying around $2,000 extra a year or $166 monthly. That’s on top of your existing mortgage payment!

 

Ultimately, it’s up to you whether you should avoid PMI. It helps a large portion of buyers afford their homes, even without a significant down payment. While it does increase the cost of your monthly mortgage payment, this is only a temporary cost.

 

If you have a plan to aggressively pay off your mortgage or at least reach that 22% equity quickly, you probably shouldn’t worry too much about taking on PMI. That being said, if you’re considering a home that’s outside of your budget, it might be worth reconsidering whether that extra expense is really worth it.

 

The Value of PMI

PMI might be an added expense, but there’s no denying that it can be a necessity when buying a home. Lenders want to ensure they’ll get a solid return on investment when supplying mortgages. That might mean taking on private mortgage insurance on top of your existing mortgage.

 

While it might be possible to avoid taking on PMI, it could be worth the extra money. Better yet, the extra insurance can be removed once the borrower has paid down enough of the principal mortgage.

 

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