Dollars and Sense: Understanding PMI

When you prepare to buy a home, it’s important to look at all of the costs. As it’s likely the most significant investment you’ll make in a lifetime, you don’t want to enter into the transaction blindly.

Being a responsible consumer means doing your homework so there are no surprises when it’s time to sign on the dotted line. For instance, among the costs associated with new homeownership can be private mortgage insurance (PMI), if you can’t put 20 percent down. Unlike other types of policies, this insurance is for the lender’s peace of mind, not yours per se.

In this scenario, you pay a monthly premium to the insurer. The coverage will pay a portion of the outstanding balance due to the creditor in the event you default on the home loan. It should be mentioned that the insurance does not preclude you from a possible foreclosure or a lower credit score should you not meet your financial obligations.

Speaking of responsibilities, the lender requires PMI because it is taking on additional risk by accepting a lower amount of upfront money (down payment) toward the purchase. You can avoid PMI by making a 20 percent down payment (or more).

You might be wondering how you might need to stow away each month for this expense. The average annual cost of PMI typically ranges from 0.55 percent to 2.25 percent of the original loan amount. At those rates, for a $150,000 mortgage, PMI would cost anywhere from $825 to $3375 per year, or approximately $68.75 to $281.25 per month. In this way, the total cost of homeownership may be more than you might anticipate. To that end. experts will tell you that estimating the cost of PMI before you get a mortgage can help you make a more informed decision.

The good news is that PMI is not designed to be a long-term obligation. Once your mortgage principal balance is less than 80 percent of the original appraised value or the current market value of your home — whichever is less — you can expect to be relieved of this burden. You should know that often there are additional requirements, such as a history of on-time payments and the absence of a second mortgage.

There are potentially other fees, depending on where you are buying, so always be sure to ask questions before signing any documents. Also, keep in mind your loan officer can help you determine whether home ownership is within reach or if you’ll need to be more financially secure.