Buying a home is an expensive endeavor. Down payment, home inspections, loan approval costs, and tax/insurance escrows are just some of the costs that need paid at the time of home purchase by the typical buyer.
Once the home purchase is done, the costs continue. The new home owner is now responsible for maintaining their new home as well as covering their mortgage payment each month.
What if there was a better way to structure the loan in the initial set-up stage that would make the monthly payment lower though? Could the home buyer make different choices at the time of loan application that would save them money during the payback period?
Yes, they could! By understanding what private mortgage insurance is and how to get creative with it, a home buyer can use this knowledge to get a lower mortgage payment on their new home.
Understanding Private Mortgage Insurance
So just what is private mortgage insurance? Private mortgage insurance, also known as PMI, is insurance purchased by a conventional home buyer that protects the mortgage lender against a loss if they ever have to foreclose on that home buyer. The home buyer doesn't select the PMI provider typically. Their lender coordinates the coverage for them and automatically adds the cost for it into the home buyer's mortgage payment.
PMI isn't always needed on a home purchase and, when it is, the cost for it will vary. Seeing it is used to protect the lender against a loss, the cost of it is lower if the lender's perceived risk of loss is lower.
Reducing PMI Costs - Step 1
The companies that provide PMI primarily base the cost of it on two things - 1) the home buyer's down payment; and 2) the home buyer's credit score.
The PMI company views the down payment in terms of the price of the home and they reduce the PMI cost when certain percentages are hit. If a home buyer puts 5% down, the rate charged is at a higher level. If they can put more down so that they reach the 10% down mark, the rate drops. at 15% down, the rate is lower and - once a home buyer has 20% down - PMI is typically not charged at all.
Seeing this insurance is meant to cover lenders against a loss in the case of a foreclosure, a home buyer who seems like less of a risk will get a lower premium as well. Private mortgage insurance companies use a home buyer's credit score to rank that level of risk. The higher the credit score, the lower the annual PMI charge.
So what are two foundational ways for a home buyer to reduce the cost for PMI? They can 1) save up a bigger down payment; and 2) take the steps needed to get their credit score as high as possible.
Reducing PMI Costs - Step 2
Sometimes home buyers don't have the time needed to save more for a down payment or improve their credit score. Does that mean that they can't reduce their PMI costs?
Not at all! It just means that they need to get more proactive with their mortgage lender to get the best terms possible. Here are two steps that will help with that:
- Ask about PMI shopping - there are multiple PMI companies out there but not all mortgage lenders will shop the coverage to more than one company. Some mortgage lenders have their preferred PMI provider and they give all of their business to them. This can cause the home buyer to pay more for the coverage than they need to. When picking your mortgage lender, ask them if they shop the PMI to more than one provider to get you the best terms. If they do not, consider finding another mortgage lender that does.
- Ask about the impact of other factors - while down payment and credit score are the main two factors considered when determining the cost of PMI, they are not the only items used to determine the cost. Some private mortgage insurance companies will give discounts for other factors like if you are buying because of a corporate relocation or if you have two people on the mortgage instead of just one. Talk to your mortgage lender about your situation in detail to make sure they are considering all of the eligible discounts when selecting your PMI coverage.
Reducing PMI Costs - Step 3
While most home buyers pay for their PMI monthly as a part of their mortgage payment, this is not the only option available. Home buyers should also consider the options of paying a lump sum upfront, having their lender cover the PMI cost in exchange for a higher interest rate, or choosing a hybrid option containing a lower upfront cost and a lower monthly charge.
The cost for these different options will vary with time and will be impacted by the home buyer's particular situation. To give a comparison of how these options might benefit a home buyer, let's look at an example.
Mark and Sue Homebuyer are buying a $300,000 home and putting 5% down. They have a 745 credit score. The interest rate for their mortgage with the typical monthly PMIost for the PMI is $72.50.
The private mortgage insurance company that the mortgage lender is using will let the home buyers skip paying a monthly mortgage insurance charge if they pay $2,625 upfront. Mark and Sue's lender can cover that cost if the set the mortgage's interest rate at 4.5% instead of 4.375%.
By choosing the 4.5% option, Mark and Sue will pay $1,444.05 per month for the principal and interest on their mortgage instead of the $1,422.96 that they would have paid at the 4.375% option, so $21.09 more. They will avoid paying the $72.50 in PMI each month though, so their overall monthly payment will be $51.41 less per month.
Selecting YOUR PMI Plan
A home buyer will have multiple options to consider when deciding how to best structure their private mortgage insurance costs. A knowledge mortgage lender can help them weigh all of the factors that need to be considered in making this decision.
Bottom line though, home buyers can save money on their monthly mortgage payment by understanding the nuances of PMI, selecting a lender who will work with them to maximize their discounts and then wisely structuring their mortgage loan and private mortgage insurance to save them the most money possible on their home purchase.