Nearly 50% of all homebuyers today have less than a 20% down payment. That means they will be required to pay an extra fee known as Private Mortgage Insurance or PMI. PMI protects the lender because the lower amount of down payment puts the loan in a slightly higher risk class.
While most borrowers today are familiar with and understand the rationale for PMI, they still don’t enjoy paying the additional premium. There is some very good news for these borrowers. Thanks to a slew of new PMI options, there are ways to make the costs almost negligible. Add in a little creativity and PMI can become quite friendly.
Let’s look at an example. Assume a homebuyer wanted to purchase a home with only a 10% down payment. The loan amount we’ll use in this example is $200,000 with a fixed interest rate of 7.5%. The mortgage payment for principal and interest is $1,399 per month. The standard cost for PMI, which is non-tax deductible, is an additional $86 per month. This brings the monthly mortgage payment plus PMI to $1,485 for a typical $200,000 loan with 10% down.
A different way of paying PMI is by doing so “up front” or with one single premium. This way the PMI is paid in one shot and can usually be built into the loan or financed. That dramatically reduces the payment and makes it tax deductible as well. There are some even more creative and interesting options. According to Mortgage Guaranty Insurance Corporation (MGIC), the premium is slashed if the loan term is reduced from a 30-year to a 25-year. So the same homebuyer in the previous example can use a bit of creativity and take a 25-year term with “up front” PMI. The cost for the “up front” PMI is a one time fee of 0.75% or $1,500 in this example. The loan amount would then be $201,500 ($200,000 loan plus $1,500 PMI up front cost) if the fee were financed. The result is a mortgage payment for principal and interest of $1,489 per month. This is only $4 more per month for a 25-year loan than for the previously discussed 30-year loan! Moreover, since the PMI on the 30-year was not tax deductible, the payment for the 25-year loan with “up front” PMI is actually cheaper by $20 per month, after tax deductions are considered (assuming a 28% tax bracket). Wow, save 5-years and $20 per month! Be sure to ask your mortgage originator about this if you are buying a home with less than 20% down.
There are a few things you should know about up front PMI. If you can’t finance the “up front” PMI into your loan, you can pay it in cash, negotiate to have the seller pay for it, or build it into the transaction with a seller contribution.
Since the “up front” PMI requires you to pay the fee at the beginning in a lump sum, borrowers fear losing this investment if they sell or refinance shortly after closing. There is more good news here too. A portion of the premium will be refunded to you if you prepay early in accordance with a published sliding schedule.
You don’t have to wait 25-years to see the benefits of this option; you’ll be building equity more quickly from the start. In fact, using the above example, you will have about $15,000 additional equity (because you will owe less on your mortgage) after 10-years by going with the 25-year term with lower net payments!
This article is based on information and research from articles written by Barry Habib