The conventional wisdom about private mortgage insurance (PMI) has long been that borrowers should try to avoid it. PMI is a requirement for conventional mortgage borrowers who put down less than 20 percent on a home — and it’s just one more cost squeezing first-time homebuyers.
Yet, in recent years, private mortgage insurers have lowered their rates.
“I am a big fan of mortgage insurance — and it’s kind of a dirty word. When you talk to customers, they don’t tend to like it,” says Emanuel Santa-Donato, senior vice president at Tomo Mortgage. “But if you look at the actual cost of the mortgage insurance relative to being able to put down 3 or 5 percent, it is quite advantageous. That money could be used elsewhere.”
What is private mortgage insurance (PMI)?
PMI is a requirement for conventional mortgage borrowers who make a down payment of less than 20 percent on a home. Although the borrower pays for coverage, PMI protects not the borrower, but the lender. Should the borrower default, or stop paying, the loan, the lender receives a payout from the PMI carrier.
PMI is a temporary expense. By law, lenders are required to cancel it when your mortgage balance drops to 78 percent of your home’s original purchase value, or when you are halfway through your loan term, whichever comes first.
Even before this scheduled date, though, you can request that your lender remove PMI once you pay down your balance to 80 percent of your home’s original value. In that case, you’d need to pay for an appraisal or broker price opinion to establish value.
For years, homebuyers have been so opposed to paying PMI that they’ve jumped through hoops, such as getting piggyback loans. With this type of loan, a buyer makes a 10 percent down payment, then takes a second mortgage for the other 10 percent — avoiding PMI, but incurring additional closing costs, not to mention a mortgage rate a bit higher than the rate on the primary loan.
Does PMI cost less now?
Today, the average cost of private mortgage insurance is about 0.4 percent of the amount of the loan. If you were paying PMI on a $400,000 loan, for example, your premium would be $1,600 a year, or about $133 a month.
As recently as 2019, borrowers could expect to spend more than that: around 0.5 percent. In the same scenario, that’d be $2,000 a year, or $167 monthly.
The averages are just averages, of course. Your PMI rate is based on a variety of factors, including your credit score, debt-to-income ratio, even the dynamics of your local housing market. You’ll pay a higher premium if you put just 3 percent down, as opposed to putting down 10 percent or 15 percent, too. PMI is designed to protect your lender against the risk that you’ll default, and the more risk the mortgage insurer perceives, the higher your premium.
A recent study by the Urban Institute illustrates how widely the cost of PMI varies. For conventional borrowers who put down 3 percent and have credit scores below 680, PMI costs more than 1 percent of the amount of the loan on an annual basis. A borrower with a 3 percent down payment and a credit score of 760 or higher, however, pays less than 0.5 percent.
Why are PMI rates falling?
The private mortgage insurance industry is made up of half a dozen carriers, a roster that includes Mortgage Guaranty Insurance Co., Radian Group, National Mortgage Insurance and Arch Mortgage Insurance. Over the past decade, those companies have adjusted their pricing models to more accurately reflect the risk posed by each individual borrower.
“Ten years ago, there were these very formulaic rate cards that each of the PMI lenders gave to the lenders,” says Chris Grimes, senior director at Fitch Ratings. “Now there’s a very dynamic process with hundreds, if not thousands, of factors.”
The new approach allows PMI carriers to more closely match each borrower’s risk profile to the premium.
“Pricing is more granular than it’s been before, and that’s how you get more precise premiums,” says Carl Tyree, chief sales officer at Arch Mortgage Insurance.
Should you pay PMI?
With home prices at record highs, coming up with a 20 percent down payment simply isn’t an option for many homebuyers, especially first-time buyers.
If you have enough financial flexibility to choose between a 20 percent down payment and something lower, though, ask yourself: “What else can you do with the money? Do you want to take that extra equity and invest it?” Santa-Donato says.
Here are two hypotheticals facing the buyer of a $500,000 home:
- Make a 20 percent down payment of $100,000. Assuming a 30-year mortgage at 7 percent, your monthly loan payment would be $2,661.
- Make a 10 percent down payment of $50,000. Your loan amount would go up to $450,000, so your monthly payment would rise to $2,994. Assuming a PMI premium of 0.35 percent, you’d pay an extra $131 in monthly PMI costs, bringing the total payment to $3,125.
There’s no right or wrong answer. Keeping the extra $50,000 in the bank or in investments would cost you $464 a month — the difference in mortgage payment between the first and second scenario. From there, it’s a personal decision about how much you value liquidity.
Bottom line
PMI remains an extra expense, but rates have come down enough in recent years that borrowers no longer need to reflexively avoid it.
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