Here it is…the series you’ve been waiting for (or the one you didn’t know you needed)! For all you out there who want to know what’s all involved in buying a home, I’m starting a series of posts on home-buying tips and advice related to the financial aspect of it all. Topics we will cover in the coming weeks include the following:
-saving for a down payment
-interest rates and terms of a mortgage
Today I want to tackle PMI because I think it’s an opportunity to lighten the load of your monthly mortgage burden by understanding how it can be avoided.
So what exactly is Private Mortgage Insurance, or PMI? According to the gov, PMI is a type of mortgage insurance used with conventional loans. Like other kinds of insurance, it seeks to protect the person lending you the money if you stop making payments on your loan.
PMI is usually required if you’re making a down payment of less than twenty percent of the price of the home. The most common way to pay for PMI is a monthly premium. If you’re not familiar with how insurance works, premium is just the amount of money you pay for an insurance policy. Typically your PMI premium just gets added to your monthly mortgage payment.
What are the upsides of PMI?
PMI can help you qualify for a loan you might not otherwise get. If you don’t have the magic number of 20% of the purchase price saved up, PMI can help you get a loan.
What are the downsides of PMI?
PMI can help you qualify for a loan, but it increases the cost of your loan. It also doesn’t offer you any protection in the event that you run into problems down the line and are unable to pay your mortgage. In the scheme of things, it’s a fee on top of the fee the bank is charging you to use their money because there is a greater likelihood that you won’t be able to pay them back for the full amount of the loan.
Now I know I’m harping on PMI a bit, that’s intentional, because ultimately not having to use PMI means you are saving money each month. I understand PMI is not “avoidable” for everyone for various financial reasons. There’s nothing wrong with having that money go out the door, you may not miss it, but that’s not exactly what the point of this blog is about, is it?!
How much does PMI really cost (i.e. how much more could you be saving)?
The amount of your monthly PMI payment (or potential savings) is dependent on a few different things:
- term of the loan (in months)
- interest rate (expressed as a percentage)
- loan amount
- loan purpose (purchase vs. refinance)
- type of rate (fixed vs. adjustable)
- estimate value of property you’re purchasing
- your credit rating
Ok, that was more than a few. Getting a loan is a bit like cooking…there are ingredients involved and if you follow the recipe, it will generally turn out the same way, but some of the nuances might mean the end result varies. The combination of all these factors we can plug into an equation and get a general idea of what your mortgage payment be, and it will generally be similar among different lenders, but it might not be exactly the same.
HSH.com has a great tool for getting an idea for what your mortgage payment might be. It even cranks out the amortization tables for you. Amortization tables are just a breakout of the components of your mortgage payment and include the payment amount, interest amount, principal reduction, any PMI payment, and the balance due for each month for the entire term of your mortgage.
The other thing to note about PMI is that once you have actually made payments equal to 20% of the home price (your principal amount), the PMY payment drops off of your total mortgage payment. Seeya PMI!
When that happens depends on the mortgage payment you ultimately agree on with your lender and the amount of time you’re taking to pay off the loan.
Next, we will walk through an example of how much PMI would be for a hypothetical loan.Let’s say you want to buy a $200,000 house using a 30-year fixed rate of 3.61% (that’s the current average rate according to http://www.hsh.com/hshtoday-sx.html) and you have good credit. Our friends at Nerd Wallet have a great article about what is considered “good” and “bad” credit scores here.
The last variable that we have to specify in the calculator is estimated home value; let’s say we are super confident in the price we got for the home is low, and that we think it’s actually worth $215,000, about 7.5% more than what we’re buying it for.
Here’s how the payment for this hypothetical loan breaks down with your first payment:
Of this $1,078 payment, $602 is interest, $373 goes toward principal reduction, and $103 goes to PMI. With each payment, the amount of the payment attributable to interest will shrink and the amount attributable to principal (the amount of your loan) will grow. After 78 payments, you will have paid down enough principal that the PMI payment will no longer be necessary because you’ve paid 20% of the home price.
If you want to see the full amortization schedule, I will be happy to send it to you, but just so you have a visual of what we’re talking about in this post, here is the schedule for the first year of payments looks like.
|Payment Number||Payment Amount||Interest Amount||Principal Reduction||PMI Payment||Balance of Loan Due|
Potential Savings (and the point of this post!)
The money saved had you not had a PMI payment? About $8,034 over a span of 6.5 years. That’s a lot of money!
For me, it’s more about the principal of the thing: I could have an extra 1,230 or so dollars a year to direct as I see fit (bulk up my savings, take a vacation, contribute to an IRA) or I can give that money to an insurance company. This is where the small choices one can make when making larger overall financial decisions like buying a house really pay off. Do yourself a favor and save that 20% principal payment and skip the PMI. Those three little letters can be costlier than they seem in the scheme of things.
Just like your momma maybe said, “just because everyone’s doing it, doesn’t mean you should do it”. She didn’t say it at the time, but her advice probably included PMI.
Keep calm and loan-hunt on, my friends. I hope this post helps you at some point in your home-buying experience. Join me in the coming weeks for more discussion on other home-buying topics like down payments and real estate taxes, or as I like to call them, PMI’s sexier home financing cousins.
All the warm fuzzies,
#personalfinance #realestate #homebuying #money #millennial #PMI #mortgage