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What is PMI?

March 17, 2020

When you’re ready to buy a house, you’ll need to make a payment during the onset of the purchase, known as a down payment. Your down payment will be a percentage of the entire loan; this percentage varies and can be anywhere from 3.5% to 20%. 

When you make a down payment, you are taking on part of the risk from your lender and reducing the amount of your succeeding mortgage. This payment is the first time you will gain equity in your property.  After paying your down payment, your mortgage covers the rest of the home’s price. For a traditional conventional loan, a lender may require at least a 20% down payment at closing. What happens if you don’t have enough money to meet that requirement? Or maybe you haven’t had the time to save for this payment.  This is where private mortgage insurance (PMI) comes in.

PMI is sold by private insurers. It is offered in association with conventional mortgages to prevent or reduce potential losses to lenders resulting from the borrower failing to make payments; defaulting. One in three borrowers buys PMI to afford a home, without a large upfront payment. 

How does PMI benefit homebuyers?

If you choose to not make the 20% down payment, you still have options for financing a home. How much PMI you’re required to purchase depends on the amount of the loan amount, and the loan-to-value ratio.  This ratio indicates how much a loan is compared to the value of your home. For example, a $100,000 valued home with a $95,000 dollar mortgage will have a loan to value ratio of 95%. Most PMI rates fall between .5% and 1% of the loan annually, which can be broken into monthly payments, although there are other choices on how to pay for PMI available to you. You’re required to obtain PMI and keep the insurance in force while paying for renewal until you build sufficient equity in the property. This is used in the event of a default; so the lender’s losses can be reduced. When the loan-to-value ratio is 78%, your mortgage lender is required to drop PMI.

Purchasing PMI may also be beneficial for you if you don’t have enough time to save 20% of the loan amount prior to closing. Purchasing PMI gives you the opportunity to be living in your dream home sooner, while making the PMI payments along the way. Multiple loan options make obtaining a mortgage not only manageable, but something to look forward to. It is important to be aware of your options, and weigh the pros and cons of each to determine what works best for you.


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