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Home buying can be a daunting process, even for the savviest buyers. For most it is the biggest financial investment they will make in their lives.
At the time of application, buyers may experience sticker shock when they see the array of fees, additional costs and taxes added to the mortgage payment. One of those add-ons can be private mortgage insurance (PMI).
Private mortgage insurance is generally required on conventional loans with less than a 20 percent down payment. It provides the lender a financial guarantee should the borrower default and go into foreclosure.
“PMI may seem burdensome to many, but it actually benefits many borrowers,” said Sue Osterman, retail mortgage manager for PNC Bank’s Cleveland East market.
Private mortgage insurance allows buyers to purchase a home sooner, increase their buying power and expand their cash options because they can put down less than 20 percent.
Many homebuyers stretch their down payment budget to put down 20 percent to avoid PMI, but Osterman says that isn’t always advisable.
“Generally, the biggest obstacle to homeownership is having enough money for the down payment and closing costs, and most first time homebuyers haven’t saved enough to put down the full 20 percent,” said Osterman, a 35-year veteran to the mortgage industry. “On the other hand, for a more experienced, savvy borrower, it may make more sense to put less down and leave their investments in place, earning a greater rate of return and equity.”
PMI also expands cash options, which may allow for home improvements.
“How many homebuyers can say they purchase a house that is perfect and move-in ready?” said Osterman. “By putting down less than 20%, buyers can use their leftover cash towards home improvements to truly make their purchase the house of their dreams.”
A popular consumer misconception is that buyers can purchase their own PMI; however, because it is insuring the lender and not the borrower, PMI is not available for purchase. Just like life insurance, PMI is based on risk.
The price of PMI depends on a borrower’s financial situation, specifically the following four main factors, which contribute to the monthly cost:
Not known to most is that PMI can also be paid up front. Called single-payment mortgage insurance, buyers pay one lump sum at closing. Depending on the situation, this can also be paid by the seller. As a result, PMI is not added to the monthly payment.
In the sidebar example, during the first 10 years, paying a lump sum at closing would cost about $2,900; however, adding up the monthly premium during that same time frame comes to $8,100.
“In addition, there is lender-paid PMI. The PMI is built into the interest rate, meaning a slightly higher interest rate, but no monthly PMI added to the borrower monthly payment,” said Osterman who worked for a PMI company for 17 years before joining PNC in 2013.
The less money you put down, the higher the premium rate is. And the shorter the term, the lower the premium.
The good news is PMI isn’t forever. If a borrower has a conventional loan, the monthly premium eventually goes away. By law, lenders must automatically cancel PMI once a buyer reaches 78 percent of the original appraised value of the home.
For first time homeowner (FHA) loans, the term is Mortgage Insurance Premium (MIP), which is government-backed and required regardless of the down payment. The difference is, MIP is required for the life of the loan.
With her long tenure in the mortgage business, Osterman has seen the ebbs and flows of the housing market and generations of homebuyers. She says the time has never been better to purchase a home, especially for younger adults, with the economy running smoothly.
“When I look at mortgage rates now, hovering around 4 percent, I am floored because I can still recall the very first loan I wrote in 1981, which was 17 percent, adjustable, with no caps. We did everything by hand; there were no fax machines or computers. We truly live in great times.”
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