By Jim Gallagher

If you’re thinking about buying a home, you’ve probably been considering how much money you can allocate towards your down payment.  That’s a good start to your planning, but it’s important to understand that in addition to your down payment, there are other lesser-known expenses you will be responsible for like Title Insurance, Transfer Tax and setting up an escrow account. One of those lesser-known expenses many homebuyers must account for is Private Mortgage Insurance (PMI).  Educating our clients on PMI and its benefits is something we do on a regular basis at the Kelly Mortgage Team. Below are some highlights and everything you need to know about PMI, when it will apply and what are the right financing options for your specific situation.

What is PMI, and why do I need it?

A 20 percent down payment can be expensive. PMI is a type of mortgage insurance that allows you to purchase your home with a smaller down payment – as little as three-and-a-half to five percent. This is great news for buyers who need more financial flexibility, and it serves to mitigate the risk the Lender is taking on by loaning more than 80 percent of a home’s value.

To understand PMI, it can be helpful to know a little about its history. In the late 1800s, companies began offering insurance to compensate lenders or investors due to losses from the default of the mortgage loan.  Unfortunately, after the Great Depression this insurance stopped being available until the 1950s, and during that period home ownership was out of reach for many Americans who couldn’t afford a large down payment. As the PMI offerings increased and became more sophisticated from the ‘50s on, it paved the way for more people to purchase homes they could afford even if they couldn’t secure a 20 percent down payment.  

Although some perceive that needing PMI is a bad thing, in reality, it has helped secure the dream of homeownership for people who could otherwise afford the payments but struggled to save the 20 percent down payment.    

How does PMI help with affordability?

As a Loan Officer, I love having this conversation with potential homebuyers early in the process.  The answer is not only incredibly important to the buyer as they try to find homes that meet their budget, it also creates an opportunity to discuss all phases of the mortgage and home buying process.  

Once we establish how much the client can reasonably afford monthly as well as the total amount of cash they have available to allocate towards the purchase, it’s time to zero in on all their financing options.  Finding the right balance between monthly payment and cash required is different for everyone and one way we can strike the right balance is through the use of PMI. For example, if a client can afford the monthly payment on a home with a $350,000 sales price but doesn’t have the $70,000 cash for a 20% down payment, the client’s options (without PMI) are to either wait until they have enough for the down payment, or to purchase a home with at a lower sales price that may not suit their needs.  In cases like this, we would recommend the client consider a smaller down payment and elect for PMI.

Because conventional PMI rates are very affordable in 2018, this can be a perfect option for buyers who would otherwise need to wait years to accumulate the necessary funds for down payment.  In most cases, the difference between allocating an additional 5% to 15% towards your down payment is significantly more expensive than the cost of PMI. And while putting 20% down toward the purchase of your home is a sound financial strategy, we encourage clients to explore parting with less cash at the outset to ensure they find the best balance between monthly payment and growing their savings.

What are my options?

There are essentially three options for Conventional PMI:

  • Monthly – This is when you will pay the PMI each month until the balance of your mortgage reaches a predetermined level, which is typically at 78% of the value of the home, then PMI is no longer required. This is generally the most popular type.
  • Single Premium – When you select this option, you will pay the premium one time at settlement.  The benefit of this option is it’s generally less expensive than the total of your monthly PMI payments.  For example, if the monthly PMI option is $55 per month and will disappear after you make 105 payments, that means you would pay $5,775 over the life of the loan. Whereas utilizing the Single Premium option, you may only be $3,350 which would save you $2,425.  
  • Lender-Paid – This option is when you elect to take a higher rate from the Lender in exchange for the Lender covering your PMI requirements.  The benefit with this type is that you do not pay monthly or add to your cash requirements, but the downside is you take a higher rate on all the money you borrowed – which typically makes this the most expensive option.  Although there are times when this makes sense, we generally do not recommend this option in a rising rate environment like the one we are currently in.

To find the best option for each client, it’s important to understand how long they expect to live in their home, have the existing mortgage, or if they plan to make improvements to the home.  If a client is purchasing their first home and will think about upgrading in a few years, we may recommend a monthly premium. At the same time, if the client doesn’t expect to make any changes to their financial situation for a while, we may recommend a single premium.  Other factors like the client’s credit score, loan size, length of the loan, and down payment percentage compared to the purchase price are all considered in making the right recommendations. There are generally a lot of options we can explore to find the best combination for each potential buyer.  

How we can help

Ultimately, a Loan Officer’s job is to listen to you and find the best financial solution for your family and your lifestyle. By exploring various types of mortgages and PMI options, we can usually find a home loan that works for each family’s unique situation. Contact me if you have any questions, or if you’re ready to get started!

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