Deciding to buy a new home can be very exciting – especially if it’s your first home. Most often, the first question you ask yourself is, “How much can I afford to spend?” While that’s a great question, the answer isn’t always clear-cut when it comes to home loans.
While many real estate and financial websites offer online calculators to assist with this step, they usually only factor in the principal and interest portions of your payment. Other costs can increase your monthly payment, such as homeowner’s insurance and property taxes.
Another figure that can increase your monthly payment is whether or not you will be required to carry private mortgage insurance or PMI.
What is PMI?
Private mortgage insurance is a protection for the lender in case you cannot make your monthly payments on your new home. While PMI varies by lender, it will typically cost you between 0.5% and 2% of your outstanding mortgage balance based on your credit score.
For example, if your mortgage balance is $200,000, you will pay between $1,000 and $4,000 for PMI annually. This figure is usually broken up over 12 months and added to your monthly payment to make the amount more affordable for homebuyers. Therefore, in this example, PMI would add $83.33 (0.5%) to $333.33 (2%) to your payment.
Who Pays PMI?
Lenders usually require PMI to be added to your loan if you do not have at least 20% equity in your new home. In other words, if you don’t make at least a 20% down payment, you may be required to carry PMI on your mortgage. The good news is that there are strategies to avoid paying PMI.
Ways to Avoid PMI
1) Make a Down Payment of 20% of Your Home’s Value.
A 20% down payment is the easiest way to avoid PMI. However, it can be challenging for many to accomplish this task – especially first-time homebuyers.
For example, if you’re buying a $200,000 home, that would require a down payment of $40,000. That’s a hefty upfront expense – and it doesn’t include other expenses due at signing, such as closing costs.
2) Use a Home Equity Loan.
Depending on your lender, you may be able to use a Home Equity Loan in combination with your mortgage and down payment.
For example, instead of making a 20% down payment, you could use an 80/15/5 option. This scenario breaks down as:
First Mortgage = 80% (Amount required to avoid PMI)
Home Equity Loan = 15%
Down Payment = 5%
Here you use a Home Equity Loan and a 5% down payment to cover the required 20% equity to avoid PMI. These options will vary by lender but are worth considering due to the lower down payment.
3) Get It Waived.
Whether or not you have to pay PMI is entirely up to the lender. If your credit score is high, you’ve had good payment history with your lender on other loans, and you have a consistent income, they may choose to waive PMI on your loan. Again, this is solely up to the lender as they assume the risk on the loan without private mortgage insurance.
4) Reach 80% in Payments.
If you currently have a mortgage and are making payments, once your home reaches 20% equity, the PMI should automatically drop off your loan.
5) Recalculate Your Home’s Value.
Home values constantly fluctuate with the market. If you believe your home’s value has risen since you originally bought it, you can have your home reappraised. However, you will most likely have to pay for the appraisal yourself, which is typically around $500.
If the appraisal shows your home’s value increased and you have over 20% equity, the lender should remove PMI from your mortgage. While paying $500 to have your home appraised may be costly, it could save you even more throughout the year. In the initial example, PMI would be between $1,000 and $4,000 annually – saving you between $500 and $3,500 per year after the appraisal cost.
We’re Here to Help!
Purchasing a home is exciting. However, before you get too far ahead in your home search, it’s wise to get pre-qualified for a mortgage. During this process, you will work one-on-one with one of our mortgage specialists to determine how much you can afford to spend, estimate your upfront costs, and review the different home loan options available.
We’re here to answer all your questions and walk you through the entire process. Please stop by any of our convenient branch locations or call (248) 745-3353 to speak with a mortgage specialist today.
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