Private Mortgage Insurance - PMI
There’s your car insurance, your health insurance...what’s that you say? You’re buying a house? With less than 20% of the home’s value as a down payment? Welp. That means more insurance for you...private mortgage insurance. Except that PMI isn’t insurance for you. It’s insurance for your bank. The interest you pay on your mortgage is like interest you’d pay on any other loan, which is paying the lender for the service of getting money sooner rather than later via a loan.
But since mortgages are so big, they’re essentially big gambles for banks. If you pay a down payment of 20% or more on your house, the banks trust you more to pay it all back, because you’ve got money in the bank. But if you don’t...that is, if your down payment is less than 20% of the house or apartment you’re buying...then the banks will still let you have your mortgage, but only if you pay for private mortgage insurance to cover themselves for taking on the risk of...you.
For example, if someone pays $200k for a home and they put 20% down, they pay $40k up front to the bank. Then the bank creates a loan for the remaining $160k, which the borrower pays off over 15-30 years (if all else goes smoothly). Since they put 20% down, they can skip monthly PMI payments, which is kind of a big deal. PMI can cost between a half % and 1% of the loan every year.
For instance, if that same someone put 10% down instead of 20% on that same $200k home, that means they put down $20k and took out a mortgage of $180k. Since their down payment is less than 20% of the house’s price, they’ll be stuck paying PMI, which would cost them somewhere around $1,000 to $2,000 per year, plus taxes (yep, PMI payments aren’t tax-deductible, unlike mortgage interest). Kind of ironic, but having less money often costs more money. Because less money means more risk. Should something go awry and you can’t make payments anymore, the bank has to then sell the house to try to regain the money from your defaulted loan. It’s a bummer for you, but it’s a bummer for your bank, too. Truth be told, the bank would rather not sell your house, since that whole affair is a whole lot of trouble, and costs money. The commission and lawyer costs, eviction sheriff bumper cars...all those expenses add up.
This is where PMI comes in. Private mortgage insurance is insurance for your lenders in case you end up foreclosing on your house. The PMI money you’ve been paying your lender goes towards an insurance policy that helps your lender recuperate the money they lent to you, especially if the house sells for less than what you originally borrowed.
How do you avoid paying PMI...money that’s just going down the drain and into an insurance policy to help your lender in the case that your life gets lit on fire (in a bad way)? You put 20% down, that’s how. Okay, but say you can’t afford to put 20% down, or it’s too little, too late, and you already put 10 or 15% down. Well, the good news is that you can stop paying PMI...eventually. That is, you can stop paying PMI once you’ve paid off 20% of your home. As long as 20% of your house has yet to be paid for in cold, hard cash, your bank will consider you “in the danger zone,” requiring PMI payments. Once you have 20% equity in your house outright, whether through your initial down payment or not, you don’t have to pay PMI anymore.
Well, as long as you tell your lender. Legally, they have stop charging you PMI payments once you tap them on the shoulder and say “Hey guys, I have 20% equity in my house now, so can you like, not with the PMI charges anymore?” If you forget to tap them on the shoulder when you have 20% equity, don’t worry...they legally have to stop charging you for PMI once you get 22% equity in your house. If you put down 10% on that $200k house ($20k) and made monthly mortgage and PMI payments (with some extra mortgage payments thrown in) until you paid down another $20k, you now have $40k equity...or 20% equity...in your home. Time to call the bank and say sayonara to those PMI payments. But if you don’t, you’ll keep paying PMI payments along with your monthly mortgage payments...that is, until you have 22% equity, which is when you’ve paid $24k in monthly mortgage payments. If you want to save money, better to tell your lender to get rid of that PMI as soon as you reach 20% equity. If you put less than 20% down on your house, it’s a race to reach 20% equity so that you can stop making those pesky PMI payments.