Once you’re ready to buy a home, you will want to have at least a 20% down payment. If you cannot afford this, then your lender will require that you obtain private mortgage insurance before handing you a loan. Lenders want to make sure they are protected if you happen to fall behind on your payments.
PMI is always an option to buy a home with a down payment. Sometimes its the only option for new home buyers, however there are several problems with PMI that homebuyers should be aware of.
- Obtaining a PMI will cost you up to 1% of your entire loan amount and you will have to pay this each year. This can add up and could cost you as much as a monthly car payment.
- PMI may not be a tax deductible. This will depend on your annual income. There is income caps for both married couples and married couples who file separately.
- If you have heirs that you would like to protect, be aware that you will need a separate life insurance. PMI will not cover your heirs and will not compensate your kids or spouse if something was to happen to you.
- Choosing a PMI is like giving away free money. If you put a less than 20% down payment on your home, you will be paying mortgage insurance until your homes equity is at 20%. This is alot of money that you will be paying out for several years.
- Once your home equity is at 20%, then you will no longer need PMI however attempting to cancel PMI isn’t very easy. You may have to draft a letter and you may have to obtain a home appraisal prior to cancelling your PMI. The entire process could take months.
- You may have to continue paying on your mortgage insurance even after you have reached the 20% equity threshold. Some lenders require that you maintain a PMI contract for a certain amount of time which will keep you obligated to keep paying. Check with your lenders for specifics.
If you earn less than the income caps that are placed, then you will most likely be able to claim PMI as a tax deductible. You can also avoid adding the cost of PMI by paying your entire mortgage insurance upfront. You may even get a discount going this route. You could also talk to your lender about adding an additional fee to your loan balance to make up for the cost of PMI.
You can avoid PMI by using a piggy back mortgage which will allow you to split up your loans. This way you might be able to pay lower interest on both loans and just avoid PMI altogether. Piggy back loans are risky because many of them have rates that are adjustable and will require that you pay in 15 to 20 years compared to your conventional loans that will require 30 years.
PMI is expensive unless you think you’ll attain your 20% home equity within a few years. If not, then choosing a piggy back loan or paying a bigger down payment will make more sense. Piggyback loans are also deductible and often used as an alternative for those who cannot afford a large down payment.