What is Private Mortgage Insurance?
Private mortgage insurance (PMI) is required if a home buyer puts down less than 20% of the home's purchase price. This insurance exists to offset the risk a lender takes when the homebuyer cannot supply an adequate downpayment. PMI will increase the cost of the mortgage, and it is typically rolled into the total monthly payment of the home.
Home buying and selling has risks, and if a home buyer cannot supply a 20% downpayment, then they may be subjected to a PMI. A PMI doesn't actually protect the buyer, but it does protect the lender if the buyer doesn't have a 20% downpayment. This protects the lender in case the homeowner defaults on the loan because the homeowner, in the beginning, will not have 20% of equity in the house.
The average annual PMI can range from about 0.5% to 2.25 % of the original loan amount each year. To put that in perspective, this means that on a $200,000 house, you could be paying an extra $1000 to $4500 every single year. This works out to paying between $90 to $400 per month.
When determining PMI premiums, credit score and loan-to-value ratios have a big influence on this cost. Basically, the higher your credit score, the lower your premium rate can be. On the other hand, if you have a high loan-to-value ratio, you can find yourself paying the higher end of PMI premiums.
A PMI will increase your monthly home cost as a home buyer, but it does afford some benefits. For example, if you have a high credit score and a low loan-to-value ratio, then the option of PMI will allow you to buy a house sooner than it would if you waited for a 20% downpayment. Because owning a home is the key to building wealth, being able to buy a home sooner can help you more in the long run, even with having PMI.