If you’ve been thinking about buying a home but aren’t quite sure you can scrounge up enough money for the down payment, private mortgage insurance, or PMI, may be an option for you. PMI is a type of insurance that protects your lender if you default on the loan. It's generally required on loans worth more than 80 percent of the appraised value of the home. Before using private mortgage insurance, however, you should consider the drawbacks as well as the benefits.
Less Money Down
Maybe your lease is about to expire, or maybe you’re just sick of paying your landlord’s mortgage when you could be paying your own. Whatever your reasons might be, if you’re in a hurry to become a homeowner and you won’t be able to save up the 20 percent down payment in enough time, PMI is obviously to your advantage. While PMI is first and foremost a protective benefit to lenders, it also enables you to get a home with less money down and achieve homeowner status much sooner than you may have expected.
Becoming a homeowner entitles you to a bevy of tax deductions, although you’ll need to itemize your deductions using Schedule A with Form 1040. While you can’t deduct your homeowners insurance, you can deduct the premiums you pay for PMI. If you pay all your PMI premiums up-front, you’ll only be able to deduct what’s applicable to that tax year.
For some people, PMI is the only way to qualify for a mortgage, and unfortunately, it can really add up. The average cost of annual PMI premiums will range anywhere from 0.5 to 1 percent of the total loan amount. Assume you manage to save up for a 10 percent down payment on a $150,000 house. The remaining balance is $135,000. Your PMI premiums will range from $675 to $1,350 annually, which is approximately $56 to $113 a month. When budgeting for a house payment, make sure you factor in the added cost of PMI if you know you’re putting less than 20 percent down.
When to Stop Paying
Knowing when you’ve achieved 20 percent equity is essential to preventing yourself from overpaying for PMI. Before the implementation of the Homeowners Protection Act of 1998, homeowners were on their own when it came to terminating PMI. The law established new rules for automatic termination and cancellation of PMI. Under the law, you can cancel PMI once you've reached 20 percent equity, but you'll have to take the initiative to do so; the automatic cancellation doesn't occur until you achieve 22 percent equity, as long as your mortgage payments are current and there are no liens against your property.
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