Wednesday, March 12, 2025

Posted in: Home Ownership, Personal Banking

PMI Insurance – What It Is, Its Pros and Cons, and Why You Might Be Paying It

Navigating the home-buying process often comes with financial terms that can be a bit confusing. One such term is PMI, or Private Mortgage Insurance. Understanding what PMI is, its benefits and drawbacks, and whether you should be paying for it can help you make more informed financial decisions.

First, What Is PMI?

Typically required when a borrower makes a down payment of less than 20% of the purchase price, Private Mortgage Insurance (PMI) is a type of insurance that protects the lender in case the borrower defaults on their mortgage. Although it protects the lender, it is paid for by the borrower, adding to the overall cost of the mortgage.

Advantages of PMI

1. Lower Down Payment: PMI allows buyers to purchase a home with a smaller down payment, sometimes as low as 3-5%. This can be advantageous for first-time buyers who may not have significant savings but want to get into a home sooner.
2. Faster Homeownership: By not needing to save up for a full 20% down payment, borrowers can buy a home earlier, potentially taking advantage of lower home prices or locking in favorable interest rates.
3. Building Equity Sooner: Even with PMI, making mortgage payments (compared to paying rent) allows you to start building equity in your home instead of waiting to save a larger down payment.

Disadvantages of PMI

1. Additional Cost: PMI is an extra monthly expense on top of your mortgage payment, so you need to budget for it. While the cost varies, it can range from 0.3% to 1.5% of the original loan amount annually.
2. No “Direct” Benefit: Unlike homeowners’ insurance, which protects you in the event of a loss, PMI is intended to protect the lender. This means that you pay the cost but don’t directly benefit from it (other than benefitting from buying a home with a lower down payment!).
3. Can’t Be Deducted in Some Cases: While in past years PMI was considered a tax-deductible expense in certain cases, tax laws have changed, making this no longer the case. In all tax instances, we suggest you check with your tax advisor to keep an eye on changes in the tax code and if you qualify for this benefit.
4. Remains In-Effect Until 20% Equity: PMI typically stays on your loan until you have achieved at least 20% equity in your home. Depending on how much you initially put down and market conditions, this could take several years. But working with your lender, when this “magic number” is reached, PMI can likely be removed! 

Should You Be Paying PMI?

Whether or not you should pay PMI depends on your financial situation and homeownership goals:

Why You Might Want to Pay PMI:

• You’re eager to become a homeowner, and current market trends show rising home prices.
• You have a steady income and are comfortable with the extra monthly cost of PMI.
• You believe that homeownership benefits, such as equity building and potential tax deductions, outweigh the PMI expense.

Why You Might Want to Avoid PMI:

• You have the ability to wait and save for a 20% down payment to avoid the additional cost.
• The extra monthly expense due to the PMI cost strains your budget and compromises other financial goals.
• Market conditions make it more advantageous to keep renting or wait for more favorable mortgage terms.

How to Get Rid of PMI

The good news is that PMI doesn’t have to last forever. Here are some ways you can eliminate it from your mortgage payment:

1. Reach 20% Equity: Once your loan balance reaches 80% of the home’s original value, you can request to have PMI removed. This requires you to contact your lender and possibly pay for an appraisal.
2. Automatic Termination: PMI is automatically terminated when your loan balance reaches 78% of the original home value, as long as you’re current on your payments.
3. Refinancing: If your home value has significantly increased, refinancing may help you reach 20% equity faster, thus allowing you to drop PMI.

Pro Tip: If your payment with PMI was within budget and not impeding your financial goals, you may want to consider paying the same amount even after PMI is removed. This additional amount will then go to help knock down the principal balance of your loan, allowing you to pay it off ahead of schedule, potentially saving you hundreds, if not thousands, of dollars in interest! 

Final Thoughts

PMI can be a valuable tool for homebuyers who want to purchase a home sooner and start building equity with less upfront cash. However, it comes at the cost of higher monthly payments. Understanding the pros and cons can help you determine if paying PMI is right for you or if waiting to save a larger down payment is the smarter move.

Do you have questions about PMI or need advice on whether it’s the right choice for you? Reach out to the home mortgage experts at Dream First Bank. Our team is just an email, call, or personal visit away and ready to guide you through your options. We’re here to help you make the best financial decisions for your home-buying journey.