Mortgage Basics - What is PMI?
by Courtney Ronan
If you're preparing to make the transition from renter to first-time homebuyer, you've undoubtedly been told by wide-eyed veterans of the homebuying process (or renters who equate homebuying with certain poverty), "Watch out for that PMI." PM what? PMI, as in Private Mortgage Insurance. It's a fact of life for homebuyers who put down less than 20 percent on their homes (and with home prices on the rise, that's most of us). From the lender's perspective, PMI is a necessary protection. For homebuyers, it's not likely to be the deciding factor that causes financial ruin; after all, you've got your principal and interest, which can make your PMI look like pocket change.
Nevertheless, first-time buyers often experience trepidation when they see that mortgage payment on paper for the first time, so the addition of a PMI isn't a welcome sight. In short, the PMI adds a weighty cherry to the top of an already overwhelming sundae.
So how exactly does PMI protect your lender? First, let it be said that PMI was designed strictly for your lender's protection and not yours. Essentially, there's nothing in the PMI for you ... except a lighter wallet.
The PMI gives lenders incentive to seek out more business - in other words, to find more homebuyers like yourself, many of whom have never bought a home before and, like you, are able to put down the bare minimum 3 percent down payment. In a sense, we can all be grateful for the PMI, because without it, if you didn't have 20 percent to put down, you'd probably be out of luck.
What lender would take the risk on a 3 percent downer?
A few factors to consider before you jump on the PMI bandwagon: First, it's not inevitable. Some lenders won't ask you to pay a PMI, so you'll want to do some comparison shopping, investigate your alternatives and discuss your options with your Realtor if you're unsure about the best route to take. If you want to make your PMI premiums tax-deductible, find a lender who will give you the option of including your PMI within the interest rate you've agreed to pay for your home loan. But with every pro, of course, there's a possible con.
If you opt for a conventional loan (versus FHA), such loans will often eliminate your PMI when you've achieved 20 percent equity. For first-time buyers, it needs to be stated that it's going to take you many, many years to reach 20 percent equity. National trends certainly indicate that most of us will move out of our homes long before we reach that mark; five to seven years is the average. But let's say you remain in your home long enough to reach that 20 percent equity milestone. If you have your PMI premiums included in your loan's interest rate, your PMI won't go away once you achieve 20 percent equity.
If you remain consistent with the national trend and either move out of your home within five to seven years or refinance it, including your PMI in your loan interest rate probably makes sense from a tax perspective. One other factor to consider: If you live in a region of the country where property values are skyrocketing and show no signs of slowing down (example: San Francisco or San Jose, Calif.), you're likely to reach 20 percent equity in a much shorter amount of time than in a market where property values are increasingly more slowly.
Homebuyers who obtained home loans either on or after July 29, 1999, have a loophole: They're entitled to the immediate cancellation of their PMIs upon their achievement of 22 percent equity. Another safeguard on your side is outlined in the Homeowners' Protection Act of 1998, which actually enables homeowners to request the cancellation of their PMIs prior to reaching 22 percent equity. Homeowners - with the exception of those with FHA loans, who are not given the opportunity to cancel their PMIs before the entire loan is paid off -- may request the cancellation of their PMIs upon reach 20 percent equity.
So while the PMI isn't a welcome sight each month, you are granted some concessions in exchange for the financial inconvenience. The silver lining of this "necessary evil" is that it allows thousands of renters each year achieve the American Dream of homeownership.