When you buy a house with a mortgage, you will have to pay for homeowner’s insurance to protect your property. But there is another kind of insurance you may have to pay for, and that is private mortgage insurance or PMI. Typically, buyers who pay less than 20% down are required by their lenders to have PMI. It may seem like an extra financial burden, but paying for PMI allows buyers who can’t come up with 20% down to buy a home. Read on, then, to find out what you should know about PMI when buying a house in Kauai.
What Is PMI?
PMI (private mortgage insurance) is a type of insurance that (typically) conventional mortgage lenders require borrowers to have if they pay less than 20% down when buying a house. It is designed to protect lenders in case homeowners default on the loan. PMI does not protect homeowners from foreclosure, but it does allow them to buy a home when they can’t afford a 20% down payment.
The standard down payment for anyone buying a house in Kauai or anywhere else used to be 20% of the purchase price. But in today’s economic environment, 20% down is just too high a financial hurdle for many (if not most) buyers. As a result, many lenders and first-time buyer programs offer mortgages requiring a smaller down payment. And that’s when PMI comes into play.
When you pay less than 20% down, though, your lender will consider the loan a riskier investment. So your lender will require you to pay for PMI as protection in the event you default on the mortgage and the home goes into foreclosure.
How Does PMI Work?
When you apply for a mortgage when buying a house, your lender will assess your risk as a borrower. One of the key measures a lender will use to assess the risk is the loan’s loan-to-value (LTV) ratio. This is the ratio derived by comparing the amount of the loan against the home’s value. With a down payment of less than 20%, the LTV ratio will be greater than 80%, and in that case, the lender will require you to have PMI.
Most of the time, you will pay for PMI monthly as part of your overall monthly mortgage payment. Occasionally, though, it is paid upfront as a one-off fee at closing.
But PMI isn’t something you’ll have to pay for throughout the entire life of the loan. If you’re current on your payments, your lender will terminate the PMI requirement when your loan balance reaches 78% of the original value of the home or, put another way, when your equity reaches at least 22%.
What Is the Cost of PMI?
So, when you’re buying a house and paying for PMI, you probably want to know what it will cost you.
On average, PMI premium rates range from 0.58% to 1.86% of the original amount of the mortgage loan. For most borrowers, this works out to around $30 to $70 dollars each month for every $100,000 in loan amount.
There are, however, a couple of key factors that determine exactly how much you’ll pay . . .
- Loan-to-value (LTV) ratio – As we mentioned, how much you pay down will affect how much you pay for PMI because it impacts the LTV ratio. The more you pay down, the less you’ll have to pay for PMI. For example, if you pay 5% down, the LTV ratio will be 95%. But if you pay 15% down, the LTV ratio will be 85%. With the smaller down payment, your lender will be taking on greater risk, and PMI payments will be accordingly higher.
- Credit score – Your credit history and credit score also play a role in determining how much you’ll pay for PMI. The version is that if you have a credit score of 760 or higher you will pay less for PMI than you would if you had a credit score of, say, between 620 and 640.
How You Pay for PMI
As we mentioned earlier, there is more than one way you can pay for PMI when buying a house. The three basic options are . . .
- Monthly – This is the most common method of making PMI premium payments. You pay on the PMI as part of your monthly mortgage payments. It makes for a larger monthly payment, but spreads out the premium payments over the course of the year.
- Upfront – Another PMI payment option is the upfront payment. You pay the full premium amount in one go usually at closing. It’s a big chunk of change all at once, but your monthly payments will be smaller this way.
- Hybrid – And then there’s the hybrid option. As the name suggests it’s a combination of the monthly and the upfront options. You pay some upfront, and then you pay out the rest in monthly payments.
How to Avoid PMI
There is in fact a way to avoid paying for PMI even if you can’t pay 20% down. But it does carry some risk.
The way to avoid PMI with less than 20% down is simply to take out two loans. You have your large mortgage loan, but you also take out a smaller loan (often at a higher interest rate) to allow you to pay 20% down. You will be committed to two loans, but you won’t have to pay for PMI.
Before taking this drastic step, though, remember that when your home equity reaches a certain level you won’t have to pay for PMI any longer. You can request that your PMI be removed when you have 20% equity in your home, or just wait till the LTV ratio reaches 78%, at which point your lender automatically removes the PMI requirement.
The Expert Assistance You Need When Buying a House in Kauai
PMI may seem pretty straightforward on the face of it, but it can actually be fairly complicated, especially when determining which of the PMI options is right for you. That’s why it’s always best to work closely with an experienced Kauai who can help guide you to the best outcome. So if you’re considering buying a house in Kauai, contact us today at 808-634-4518.