When buying a home, there are all sorts of costs that you’ll be expected to pay overtime. Not only will you have to pay your mortgage, but property taxes and home insurance as well. Depending on the circumstances, you might even have to pay private mortgage insurance.
You might be wondering what private mortgage insurance is and how might it affect your home loan. Let us help ease your mind with this handy guide to private mortgage insurance.
What is Private Mortgage Insurance?
Private mortgage insurance is essentially just insurance for a mortgage. It covers the mortgage lender if the owner of the house isn’t able to pay the mortgage. The insurance will kick in and ensure that the mortgage company isn’t left holding the bill.
Private mortgage insurance isn’t always necessary. However, it’s quite common.
It’s most typically required for homeowners with little equity in their homes. For instance, in many cases, if your down payment is less than 20%, you’ll be forced to pay private mortgage insurance until 20% of the house is paid off.
The reason low-equity homeowners are made to pay for private mortgage insurance is that they’re seen as high-risk borrowers. Because they didn’t have the money for the standard 20% down payment, they’re not seen as being as financially reliable as those that did.
Now, this might make private mortgage insurance sound like a bad thing. In fact, it’s highly beneficial in that it allows many more individuals to become homeowners. Were it not for private mortgage insurance, residential mortgage services would be less likely to lend money to low-equity borrowers looking for homes.
Different Types of Private Mortgage Insurance
Private mortgage insurance isn’t always paid or presented in the same way. In fact, there are different types of private mortgage insurance, and they include the following.
Single-Premium Mortgage Insurance
First, we’ll discuss single-premium mortgage insurance or SPMI. This is paid at the beginning of the real estate transaction and is generally included in the closing costs of the home.
When you pay your private mortgage insurance in this way, there are no refunds available. This is true even if you refinance for a lower rate at a later date.
Buyer-Paid Mortgage Insurance
Next up is buyer-paid mortgage insurance or BPMI. This type of private mortgage insurance is paid on a monthly basis. In some cases, it’s paid separately from the home’s mortgage. In other cases, it’s rolled into the mortgage, thereby increasing both total and monthly costs.
In either case, this PMI’s cost will change after refinancing. As such, if you choose to refinance your mortgage in the future, you’ll save money on private mortgage insurance as well as your mortgage itself.
Split-Premium Mortgage Insurance
Another option is split-premium mortgage insurance or SPMI. This is when you pay a portion of the PMI at the beginning of the purchase and then pay the rest of it on a monthly basis.
While you can’t be refunded for the amount that you pay at the beginning of the transaction, you could potentially have your monthly payments lowered after refinancing.
Lender-Paid Mortgage Insurance
There is a way to forego private mortgage insurance payments before 20% equity, and that’s by handing them off to your mortgage lender. However, as you might expect, there’s a catch.
When you do this, the interest rate on your mortgage goes up. As such, you end up paying the same price that you’d be paying were you using a different type of mortgage insurance.
In addition, the locked-in interest rate doesn’t change, even after you’ve reached 20% equity. Therefore, you’ll be paying it for the life of the mortgage, and not just for 1/5th of its existence.
This type of PMI is best avoided by the borrower.
Federal Home Loan Mortgage Protection
If you obtain an FHA loan, you might be eligible for federal home loan mortgage protection. This only requires payment until you have 10% equity, not 20%. In addition, once your loan has reached 11 years of age, you can forego payments of this PMI.
How Much is Private Mortgage Insurance?
Though there is some give and take, private mortgage insurance usually costs between 0.5% and 1% of the home’s total purchase price per year. Therefore, if your home costs $250,000, your yearly private mortgage insurance burden would be between $1,250 and $2,500.
Divide those figures by 12, and you’re paying somewhere between $104 and $208 a month. So, as you can see, this can add quite a bit to your monthly housing payments.
How Long Must You Pay Private Mortgage Insurance?
You’re not forced to pay private mortgage insurance forever. Generally speaking, once you reach 20% equity in your home, you can stop paying PMI. At 22% equity, your lender is forced to cancel PMI on your behalf.
This is why (amongst other reasons) it’s wise to put down as large a down payment (up to 20%) as possible. The more equity you have in the home to start with, the less you’ll have to pay in private mortgage insurance overall.
Need a Mortgage Loan?
As you can see, private mortgage insurance is common in many residential real estate transactions around the country. While it does add to your monthly costs, it also allows you to become a homeowner much sooner than you would be able to otherwise. So, if you don’t have that 20% down payment, fear not. It is still possible for you to buy a home.
Looking for a mortgage loan right now or a refinance? Compass Mortgage has you covered. Offering mortgages of all kinds, we’ll work with you to ensure that you get the right mortgage for your home.
Apply for a mortgage now and see how we can help you get the home of your dreams.