Did you know that home buyers can qualify for preferable loan options even if they do not have a 20% down payment prepared? The key to this strategy is that borrowers are required to opt for mortgage PMI.
Mortgage PMI is an acronym for “private mortgage insurance.” By adding this protective policy to your loan — and tacking on the costs associated with the policy to each monthly mortgage payment — lenders can protect their interests and borrowers can access their mortgage loan without having to make a 20% down payment.
Let’s take a deeper look at mortgage PMI to help home buyers determine if this is something that they’re interested in leveraging when it comes time to apply for a mortgage loan.
What is Mortgage PMI?
Mortgage PMI is a financial protection policy taken out on behalf of the borrower to protect the investment made by the mortgage lender.
Mortgage PMI is not a requirement for all mortgage loans. However, it is usually required by the lender when they have negotiated with a borrower to waive certain qualification standards, such as lowering the down payment requirements of a certain loan type.
How Does Mortgage PMI Impact Down Payment Requirements?
Down payments and PMI essentially serve the same purpose. This is to offer financial protection to the mortgage lender, helping to ensure that the lender does not incur a loss by lending money to the borrower.
A down payment provides a lump sum upfront payment towards the total cost of the loan to help ensure that the borrower has the financial power to afford their loan, and will not end up defaulting.
Mortgage PMI offers an external layer of protection for mortgage lenders, where the insurance policy will cover the loss incurred by the lender if the borrower defaults on their loan or becomes unable to pay.
As a result, many mortgage lenders will waive down payment requirements in exchange for adding on a mortgage PMI policy onto the loan.
How Much Does Mortgage PMI Cost?
Private mortgage insurance is bundled into your mortgage costs, and a portion of the annual payment is broken down and applied to each monthly payment.
As a result, mortgage PMI increases the total cost of your mortgage and each monthly payment made. However, it can help borrowers access substantial savings because the cost of mortgage PMI is likely less than that of a 20% or more down payment made at the transaction’s closing meeting.
The cost of PMI policies added to a mortgage varies depending on the insurer chosen. However, Freddie Mac estimates that borrowers end up paying between $30 and $70 per month for every $100,000 borrowed to purchase the home.
Calculating an Example
Let’s look at an example to gauge the total costs of private mortgage insurance policies over the lifetime of a loan compared to a 20% down payment on the same purchase:
You are purchasing a home for $300,000.
A 20% down payment on this purchase would total $60,000 paid up front to the mortgage lender upon closing.
On the low end, at $30 per $100,000 borrowed, a private mortgage insurance policy would cost $30 x 3 (as $100,000 goes into $300,000 three times) per month. That is about $90 per month for PMI costs. Over a year, that is about $1,080 in PMI. On a 30-year mortgage, that totals about $32,400 in mortgage PMI costs. At this PMI rate, the total paid for the insurance policy is substantially less than the $60,000 down payment.
On the high end, at $70 per $100,000 borrowed each month, the monthly cost for PMI would total $210. The annual PMI costs at this rate totals $2,520. On a 30-year loan, the total expense for PMI is $75,600. At this rate, the borrower ends up paying more in PMI than they would have with a minimum 20% down payment on the same purchase.
Since the PMI rate varies, it’s important to speak with your lender to gain a full understanding of your estimated PMI expenses before you move forward with a policy.
Pros and Cons of Mortgage PMI
- Borrowers who cannot afford a 20% down payment can still gain access to loan packages and preferable loan terms by negotiating a PMI policy.
- Borrowers can boost their qualifications with lenders.
- With a low PMI rate, it’s possible to pay less to the loan’s total PMI than you would toward a 20% down payment.
- Borrowers are increasing their month-to-month mortgage payments with the added PMI expense.
- Depending on the rate, borrowers may end up paying more for the total PMI than they would for the 20% mortgage rate.
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