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What is PMI and How Does It Work?

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What is PMI?

This week, the White House announced plans to lower the private mortgage interest rate from 1.35% annually to 0.85% annually. This is big news, especially for first time homebuyers. Unfortunately, many consumers don’t understand what PMI is and how it impacts their monthly mortgage. I thought I’d dedicate this week’s Q&A with Kevin blog to answering a question from a Facebook fan on this very topic.

Michael from Winter Garden Asks:

What is ‘PMI’ (Private Mortgage Insurance) and How Does It Work?

When you buy a home and take out a mortgage, you have the honor of sending a check to the bank each and every month. In that payment, there is always a portion going towards your principle (the amount of money you borrowed to buy the home) and the interest (the cost of borrowing that money). In addition to these two items, there are often a few other things like property taxes, home owner insurance, and the dreaded PMI. Private Mortgage Insurance, or PMI, could be a significant portion of the monthly payment, sometime several hundred dollars so it is very important that you understand what it is.

What Is PMI (Private Mortgage Insurance)?

PMI stands for private mortgage insurance and is also sometimes referred to as simply mortgage insurance (MI). This “insurance” is there to protect you, it is there to protect the financial institution that loaned you the money to borrow the home.

When obtaining a home loan, it is customary for a borrower to put at least 20% of the purchase price down leaving only 80% of the purchase price to be financed. When this happens, it lowers the risk for the bank since if you don’t pay, they can foreclose on the home and resell it to recover all of their costs. However, there are also some great programs in the marketplace to help first time homebuyers and those that can’t afford a 20% down payment. Programs like USDA, VA, and FHA loans allow borrows to purchase a home with down payments ranging from 3.5% to $0 down. Loans with smaller down payments are statistically carry a significantly higher risk of default so banks require those buyers to carry PMI.

Will My PMI Ever Go Away?

This is a great question and the answer depends on the type of loan that you get. On a conventional loan, for example, the PMI portion of your payment will go away once your remaining principle has reached the 80% loan-to-value (LTV) mark. For FHA loans, the PMI remains on the loan for the life of the loan. The only way to remove PMI would be to refinance the home with a conventional loan product. While this will potentially save you on your monthly mortgage payment, you’ll also have closing costs when you refinance. I highly recommend you consult your financial advisor before refinancing a home to make sure that it will be beneficial.

I hope this has helped you to understand what PMI is and how it impacts your monthly mortgage payment. If you have any other questions regarding buying or selling a home, please feel free to email me at kevin@connectwithkevin.com or call me at 321-250-5222, extension 101.

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