The following contribution is from another author.
While going through the steps of buying a new home loan or refinancing your current mortgage, you’re likely to encounter a lot of smaller costs that get added to your overall monthly loan payment. There is one in particular that can catch people off guard, though: PMI. It’s an additional cost that can be added at your lender’s discretion, often when the mortgage meets certain qualifications. If you were surprised to see it as part of your payment, here’s what you need to know to calculate the cost and factor it into your budget.
What Is PMI?
PMI, or private mortgage insurance, is an additional cost that can be added to your monthly mortgage payments after taking out your initial loan or refinancing. It’s added to protect the lender in the event that you default on your home loan. Since the policy is taken out to protect the lender, you don’t need to worry about shopping around for policies or remembering to pay the additional cost yourself. Your lender will do all the footwork, only coming to you once it’s time for the cost to be paid. There are two main situations where PMI is employed:
1. A Down Payment Below 20 Percent of the Purchase Price
Most conventional wisdom says that when buying a home, you should be prepared to pay at least 20 percent of the total purchase price as your down payment. If you are unable to put down 20 percent for whatever reason, your lender may determine your loan is higher risk and decide to take out a PMI policy for it.
2. Refinancing With a Loan-to-Value Ratio Over 80 Percent
If you’re not taking out a new loan and are instead refinancing a previous one, most lenders will expect your loan-to-value, or LTV, ratio to be 80 percent or less. But what does that mean? In the simplest terms, your LTV ratio compares the current market value of your home with the amount of your mortgage. To calculate it, you just need to divide your new mortgage amount by that market value. This will give you the percentage you need to see where your LTV ratio is.
If the market has shifted in the time between when you took out your initial loan and the refinance, it’s well worth determining this number. Your property value may have increased in the intermittent period, potentially shifting your LTV in your favor.
What Should You Expect to Pay for PMI?
The cost of your PMI will usually be determined as a percentage of your current loan. Your lender will determine this number, primarily based on two factors:
1. The Size of the Loan
Generally speaking, larger mortgages will have a higher PMI cost. One percent of $300,000 is always going to be less than one percent of $500,000.
2. Your Credit Score
As with other insurance policies or loans, your credit score will likely have an inverse relationship to your PMI. That is to say, someone with a higher credit score will pay a lower PMI premium, while someone with a lower credit score will pay a higher one.
Lenders typically have guidelines they follow to determine the percentage they’ll add to your loan. If you haven’t been provided with the numbers yet, ask your lender what they’re planning on adding. Once you have that percentage, you can estimate how much you’ll pay.
How To Estimate Your PMI Insurance Cost
Once you know the rate at which your lender will take out your PMI, you can do a little math to calculate exactly how much you’ll end up paying each year. Here’s how to work out the insurance cost:
1. Determine Your Property’s Value
Find out how much your property is currently worth. You’ve likely already found this number, but if the market has shifted since you last checked, its value may have changed. Again, this is particularly worth doing if you’re refinancing since some time may have passed between your initial loan and refinance.
2. Figure Out the Total Loan Amount
This step is simple. For a new mortgage, all you need to do is subtract your down payment from the home’s total price. For a refinance, you start with your current mortgage balance.
3. Put It All Together
With your total loan amount and the PMI rate your lender provided, you can determine how much you can expect to pay each year. Take the total amount you have to pay off, then multiply it by the insurance rate. This will give you your cost in PMI. If you want to know how much you can expect to be added to your monthly payment, divide that number by 12.
Paying for PMI
If you’re trying to figure out when you need to plan to pay for PMI, there are a few possibilities. Your lender may allow you to choose one that works best for you, or they may only work with one. Regardless of how much input you get in the process, these are the most common plans:
Paying Monthly as Part of Your Mortgage
This is the most common PMI payment plan. When determining your monthly payments, your lender will just fold the cost of PMI into the total. You’ll end up with a higher mortgage payment each month, but you won’t need to worry about paying a larger price at the start of the term.
Paying for Everything Up Front
Instead of paying the insurance cost for PMI along with your monthly payment, you may instead be able to pay off the complete cost at once. You’ll end up with an additional closing cost once finalizing the loan, but you will also set yourself up with a lower monthly payment.
A Combination of Both
Finally, you may be able to choose a combination of both options presented above. In this scenario, you can partially pay off the PMI as a closing cost up front and then have the remaining amount added to your monthly payments going forward.
Low-down-payment home loans with PMI make purchasing a home an affordable option for more people. If you’d like to discuss any questions or your options for a home loan and PMI insurance costs, contact the mortgage experts at Solarity Credit Union. They can help you achieve homeownership sooner.