If you’re purchasing or refinancing a house with less than 20 percent equity, you’re going to be subject to having a PMI. Here’s what you need to know regarding private mortgage insurance with regards to financing your house…
When you have less than 20 percent equity on your house the mortgage company is going to require you to have private mortgage insurance which insures the loan if you default on your mortgage. To get the lowest cost of PMI the magic number generally is 15 percent equity and a credit score greater than 740. Obtaining private mortgage insurance is available if you don’t have these numbers; however, the costs can change. Following are the three types of PMI and how they might benefit you when buying or refinancing a house.
This is the most common type of mortgage insurance as it is the simplest to compute. It’s usually based on anywhere between .5 to 1 percent of your loan amount on an annual basis.
Advantages: You can discharge the PMI after 20 percent equity by calling your lender and petitioning the removal. It will be up to your individual lender to allow the monthly PMI to be removed.
Disadvantages: The lender may not let you out of the PMI 20 percent equity, forcing you to refinance and to drop the PMI while taking a market interest rate. The lender must remove the PMI at 22 percent equity of the original value at original application based on an amortization schedule. This generally takes around 120 months.
Single pay mortgage insurance
This allows you to essentially pre-fund the PMI without having a monthly PMI. You don’t have to re-finance and you never have to worry about discharging the PMI with your current lender.
Advantages: Monthly mortgage payments are significantly lower with no monthly PMI.
Disadvantages: It is pre-paid so there is no refund or discharge ability in the future.
Split pay mortgage insurance
This means you can finance half of the mortgage insurance and then cash finance the other difference or you can finance half of the mortgage insurance and then elect to take a monthly PMI premium. Either way, this allows you to have a little bit more flexibility with your cash and your monthly payment.
Advantages: A lower monthly payment which means lower debt to income ratio increasing your borrowing power.
Disadvantages: You’re still paying a portion of that PMI and you can’t discharge any of the PMI.
To be clear you cannot discharge the PMI on a single pay mortgage insurance or on a split pay mortgage insurance. The only PMI options that will allow you to discharge the PMI is electing to take the full monthly amount. Having a lower monthly mortgage insurance premium means your debt to income ratio is going to be lower. In other words, what you give up in future borrowing power is retained with cash if you elect to do the monthly PMI.
Whenever you are buying a house or refinancing a house and you have less than 20 percent equity to work with you will come into one of these situations with regards to PMI. There is another alternative which is, a lender paid mortgage insurance; however, that also contains a higher interest rate usually more than a market rate. This higher rate offsets the benefit in most cases.
Let’s say for example you’re looking at a 30-year mortgage at 4.75 percent on a 30-year fixed rate and a monthly PMI at $300 per month. It would be reasonable to expect to take on an interest rate somewhere around 5.625 percent to have lender paid PMI. Based on your size of a loan that could very easily offset $300 a month which negates the benefit especially when considering how much interest expense you will pay over the total term of the loan.
If you’re looking to get a mortgage, consider all your options and weight them against your short and long-term housing plans.
Scott Sheldon is a local mortgage lender, with a decade of experience helping consumers purchase and refinance primary homes second homes and investment properties. Learn more at www.sonomacountymortgages.com