What Is PMI and How Does It Work?
PMI is a form of mortgage insurance that borrowers with a down payment of less than 20% of the home’s purchase price are usually expected to pay for a traditional loan. Many lenders have low-down-payment plans that allow you to put as little as 3% down on a home. PMI, which covers the lender’s investment in the event you default on your mortgage, is the price of that flexibility. In other words, PMI protects the investor rather than you.
In the event of a default, PMI aids lenders in recouping more of their funds. Since you hold a smaller interest in your house, lenders need coverage for down payments of less than 20% of the purchase price. Mortgage lenders are lending you more money up front, so you risk losing more money if you default within the first few years of ownership. Mortgage insurance is required for loans insured by the Federal Housing Administration, or FHA loans, but the rules are different from those for traditional loans (more on that later).
The Price of PMI
According to Freddie Mac, a government-sponsored company that buys and sells mortgages on the secondary mortgage market, you’ll pay between $40 and $80 per month for every $100,000 borrowed. Keep in mind that the amount you pay depends on your credit score and your loan-to-value ratio, which is the ratio of the amount you owe on your mortgage to the value of your house.
You could subtract the expense of PMI from your federal taxes in previous years. Congress voted not to renew the provision for 2017 and beyond, so you can no longer subtract PMI payments from your annual taxes. (The deduction was later reinstated, but only for 2017.) It will be phased out beginning in 2018.)
PMI can be charged in one of two ways: a one-time premium paid at closing or monthly premiums. In certain cases, lenders use PMI as a monthly fee in your mortgage payment. Your PMI balance will be itemized in the Projected Payments section on the first page of each document when you collect your loan estimate and closing disclosure papers.
You can also pay for PMI as part of your closing costs. On page 2, section B, of the loan estimate and closing disclosure forms, you’ll notice this premium. The disadvantage of this choice is that you would almost certainly not be reimbursed if you transfer or refinance your mortgage. You may be required to pay both upfront and monthly premiums in some situations.