Private mortgage insurance, known as PMI in industry-speak, is a type of insurance that protects lenders against borrower default.
It is required when the loan amount is in excess of 80% of the appraised value of the home.
In short, PMI becomes necessary when the loan gets risky enough that the lender may lose out if they have to foreclose on the borrower.
After all, if they can’t foreclose and sell the home for a profit, they’ll be in hot water.
Think Great Recession, when seemingly every home in America was worth less than what the borrower owed to the bank.
So to recap; you are paying for an insurance policy that protects the bank against you. Seems unfair, but you’re basically paying for the increased risk.
If you want to avoid it, bring more money to the table.
Costs of PMI Then and Now
The Good Old Days:
Back when we were all rich from selling each other homes, the charges for PMI insurance were typically paid up front (at closing).
You could have expected to pay points, up to 2% or more.
For example, if your loan amount was $180,000 (90% of the value of your home, 10% down payment) you might have had to bring $3,600 to the closing table to cover the cost of private mortgage insurance.
The New Deal:
Things have changed. Now, your PMI payments are spread out over the life of the loan. The $3,600 charge in the first example could now be just a few dollars per month for as many as 20 years on a 30-year mortgage.
Why not all thirty years? Well, hopefully your home will appreciate (and your mortgage will be paid down) to a point where you existing loan is not more than 80% of the value of your home. That’s when you can ditch PMI.
Factors That Determine Cost of Private Mortgage Insurance
The amount of private mortgage insurance you pay over the life of the loan is tied to the amount of your down payment.
Things like credit score, loan amount, amount of coverage, and transaction type (refinance vs purchase) also come into play here.
So if your down payment is just 5%, you can expect to pay more per month than if you were to put 10% or 15% down.
And if your credit score is 620 vs. say 720, expect a higher monthly premium.
Essentially, anything that drives up your mortgage interest rate will also increase your private mortgage insurance costs.
If you have a large amount, you may be stuck paying a couple hundred dollars a month for private mortgage insurance.
These days, paying nothing at closing just isn’t a reality. So don’t forget your check book.
The private mortgage insurance company will likely want to collect an escrow equal to two months’ insurance premium at closing, i.e. between $200 and $400 when using the example above.