You should ideally save aside money for a 20% down payment before purchasing a property. If you’re taking out a traditional mortgage, it’s likely that your lender may need you to get private mortgage insurance (PMI) before approving the loan if you can’t. If you don’t pay your mortgage, the insurance will defend the mortgage firm.
For borrowers of FHA loans, the Federal Housing Authority has a comparable but somewhat different mortgage insurance premium requirement. Although both kinds of loans may benefit from avoiding PMI, it is not the topic of this essay.
Purchasing a home with PMI seems like a terrific method to avoid having to save as much money for a down payment. For new homeowners, it is sometimes their only choice. There are valid reasons to attempt to avoid requiring PMI, however. Here are six, coupled with a potential workaround for individuals who cannot afford a 20% down payment.
- When you don’t pay your mortgage, the mortgage company is safeguarded by PMI insurance.
- However, there are several reasons to strive to keep from using PMI.
- In rare cases, a piggyback mortgage may be used to avoid PMI.
6 Reasons To Avoid Private Mortgage Insurance
Six Good Reasons to Avoid Private Mortgage Insurance
The yearly cost of PMI ranges from 0.5% to 1% of the total loan amount. Accordingly, assuming a 1% PMI rate, you may spend as much as $1,000 year, or $83.33 per month, on a $100,000 loan. However, Zillow estimates that the typical listing price of houses in the United States is approximately $250,000 (as of September 2020), which suggests that households may be paying more like $3,420 year on insurance. That is equivalent to a modest vehicle payment!
2. No Longer Deductible
PMI was remained tax deductible up to 2017, but only if a married taxpayer’s annual adjusted gross income was under $110,000. This left a large number of dual-income households in the cold. The mortgage insurance premium deduction was completely eliminated by the 2017 Tax Cuts and Jobs Act (TCJA), which took effect in 2018.
3. Your Heirs Get Nothing
When most people hear the phrase “insurance,” they imagine that their spouse or children would be compensated financially in the event that they pass away, but this is untrue. Any such insurance has the lending institution as its only beneficiary, and the benefits are remitted to the lender immediately (not indirectly to the heirs first).You’ll need to get a different insurance policy if you wish to safeguard your heirs and provide them money for living costs after your passing. Do not believe that PMI will benefit anybody other than your mortgage lender.
4. Giving Money Away
Homebuyers who put less than 20% of the purchase price down will be required to pay PMI until the home’s overall equity exceeds 20%. You are essentially throwing away a lot of money by doing this, which may take years. To put the price into better perspective, consider what would happen if a couple with a $250,000 home invested the $208 per month they were paying for PMI in a mutual fund that earned an 8% annual compounded rate of return. Within 10 years (assuming no taxes were deducted), that money would have grown to $37,707 (assuming no taxes were deducted).
5. Hard to Cancel
As was already noted, you normally stop paying PMI once your equity reaches 20%. The monthly burden cannot be removed by just skipping a payment, however. Many lenders demand that you write a letter asking that the PMI be cancelled and insist that the house be officially appraised before it is cancelled. Overall, depending on the lender, this might take a few months, during which time PMI must still be paid.
6. Payment Goes On and On
One other thing that has to be brought up is the fact that certain lenders demand that you keep your PMI contract active for a specific amount of time. Therefore, even if you have reached the 20% barrier, you can still be required to continue making mortgage insurance payments. Check your PMI contract’s small language to see whether this applies to you.
PMI isn’t automatically canceled until your equity hits 22%.
How to Avoid Paying PMI
In rare cases, a piggyback mortgage may be used to avoid PMI. You may engage into what is known as an 80/10/10 agreement if you wish to buy a property for $200,000 but only have enough money saved for a 10% down payment. You will take out a loan for $160,000 (or 80% of the property’s total value), followed by a piggyback loan for $20,000 (or 10% of the value). Last but not least, you contributed the last 10%, or $20,000, to the deal.
You may be able to avoid PMI entirely by dividing the loans and deducting the interest on each of them. There is, of course, a catch. The conditions of an apiggyback loan are often dangerous. Many include balloon clauses, flexible interest rates, or are due in 15 or 20 years (as opposed to the more standard 30-year mortgage).
The Bottom Line
PMI is pricey. It definitely makes sense to wait until you can make a bigger down payment or pick a less costly property, which will make a 20% down payment more reasonable, unless you believe you will be able to achieve 20% equity in the home within a few years.
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