A Guide to PMI for Springtime Homebuyers

If you’ve heard of private mortgage insurance (PMI), you’ve likely seen some conflicting opinions about it. One position is that PMI should be avoided at all costs. Another is that PMI isn’t a big deal, especially when a down payment of at least 20% is required to avoid it—a potentially significant amount with today’s high housing prices. So, what’s the right choice? It depends. Once you understand the basics of PMI and when it may or may not make sense, you can build a homebuying strategy tailored to your needs. 

What is PMI?

PMI serves as a safeguard for lenders in case a borrower defaults on their mortgage payments. If you're taking out a mortgage with a down payment below 20%, many lenders will require you to have PMI. This insurance policy effectively protects the lender by covering a portion of the outstanding loan balance if you're unable to make your mortgage payments. Typically, PMI costs between 0.5% to 1% of the loan amount annually, paid monthly as part of the mortgage payment. For borrowers, this means higher monthly payments.

When it makes sense

While PMI might seem like an additional expense, it can actually benefit homebuyers in certain situations. For instance, if you're unable to make a substantial down payment upfront, PMI can help you qualify for a mortgage that you might not otherwise be eligible for. This is particularly advantageous in competitive housing markets where home prices are rising, as waiting could mean missing out on opportunities or facing higher prices later.

Additionally, PMI might make sense for buyers who expect their financial situation to improve over time. If you anticipate salary increases, bonuses, or other financial windfalls in the near future, PMI can bridge the gap until you're able to reach the 20% equity threshold required to remove PMI. In such cases, the cost of PMI in the short term may be outweighed by the benefits of homeownership and potential appreciation in property value.

You can also eliminate PMI once you've built sufficient equity in your home, making it a more temporary expense. This can be achieved through regular mortgage payments, appreciation in property value, or home improvements that increase the home's value. Once you reach 20% equity, either through paying down the mortgage balance or due to appreciation, you can request to have PMI removed. 

Refinancing your mortgage when you've built up significant equity in your home can be another strategy to drop PMI. By refinancing to a loan with a lower loan-to-value ratio, you can often eliminate the need for PMI, potentially saving thousands of dollars over the life of the loan. By Federal law, lenders must cancel PMI on conventional mortgage loans if the term is at its halfway point or if the loan balance is 78% or less of the home’s original value. 

When it may not make sense

For buyers who can afford a substantial down payment of 20% or more, PMI becomes unnecessary. Putting down a larger down payment not only eliminates the need for PMI but also reduces the overall cost of the loan, as it lowers the principal amount and could potentially secure a lower interest rate.

Secondly, if you expect your home's value to increase significantly in a short period, thereby reaching the 20% equity threshold sooner, paying for PMI could be viewed as an unnecessary expense.

Lastly, for individuals with tight budgets or limited financial flexibility, the additional cost of PMI can strain finances and make homeownership less sustainable. If this is your financial situation, it may be prudent to wait and save until you can afford a larger down payment to avoid PMI altogether—or reevaluate the amount of home you’re willing to buy. 

The best way to approach the spring homebuying season is to familiarize yourself with your options and identify the best one for you. Consider whether the benefits of a lower down payment are financially advantageous to you—or whether a 20% down payment or higher will put you in a better position. A mortgage loan officer from General Electric Credit Union (GECU) is happy to walk you through these options, and the mortgage solutions available. Schedule an appointment to start the process. Or get pre-approved for a mortgage loan online!