If you plan to buy a home in Berks County and can only afford a down payment of less than 20%, your lender may require that you purchase Private Mortgage Insurance (PMI). What is it and who does it protect?
What Is Private Mortgage Insurance (PMI)?
Typically lenders will require borrowers to purchase PMI when they make a down payment of less than 20% of the home's purchase price.
Whenever a borrower puts down less than 20% of the purchase price of the property, the loan-to-value ratio of the mortgage is greater than 80% (the higher the LTV ratio, the higher the lender's risk of default).
The policy does not protect the owner's investment in the home; instead, it protects the lender's investment. However, PMI allows some people to own properties sooner.
There are additional monthly costs associated with PMI, so borrowers must continue to pay it until they accumulate enough equity in their home that borrowers are no longer considered high-risk by the lender.
Your PMI can cost you anywhere from 0.25 to 2% of the loan balance each year, based on the amount of the down payment, the length of your mortgage, and your credit score. There are several major PMI companies in the United States, which charge similar rates, which are adjusted annually. Since PMI is a percentage of your mortgage, the more you borrow, the more PMI you’ll pay.
Although one could argue paying PMI is expensive, so would continuing to rent and possibly missing out on market appreciation over a longer period of time.
How Does PMI Work?
For starters, it is important that you understand how PMI works. For example, assume you put down 10% and the loan is for the remaining 90% of the property value—$20,000 down and a $180,000 loan. Mortgage insurance limits the lender's losses in the event they have to foreclose on your mortgage. That could happen if you lose your job and are unable to pay your mortgage for a number of months.
The mortgage insurance company covers a certain percentage of the lender’s loss. For our example, let’s say that percentage is 25%. So if you still owed 85% ($170,000) of your home’s $200,000 purchase price at the time you were foreclosed on, instead of losing the full $170,000, the lender would only lose 75% of $170,000, or $127,500 on the home’s principal. PMI would cover the other 25%, or $42,500. It would also cover 25% of the delinquent interest you had accrued and 25% of the lender’s foreclosure costs.
You might wonder why the borrower has to pay PMI if PMI protects the lender. In essence, the borrower compensates the lender for taking on the higher risk of lending to you—vs. lending to someone putting down a larger down payment.
- If your down payment is less than 20% of the home's cost, you'll need private mortgage insurance (PMI).
- The PMI is meant to protect the lender, not the borrower, from potential losses.
- There are four main types of mortgage insurance you can purchase: borrower-paid mortgage insurance, single-premium mortgage insurance, lender-paid mortgage insurance, and split-premium mortgage insurance.
- You will need a specific type of insurance if you apply for a Federal Housing Authority loan.
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