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Many of us are told by financial gurus and experts that paying private mortgage insurance (PMI) is a waste of money.
PMI is a fee you pay on your mortgage until you owe 80 percent or less of what your home is worth. It’s one reason why so many experts advise homebuyers make a 20 percent down payment; if you do, you avoid the evils of paying PMI.
But is mortgage insurance worth it in some instances? You might be surprised to discover that PMI isn’t always the terrible idea we’re often told it is. Depending on your situation and long-term goals, it might make sense to skip the 20 percent down payment and pay PMI.
Why do lenders require PMI and how much does it cost?
If you don’t make a 20 percent down payment, lenders may view you as more likely to default on your mortgage. PMI is designed to protect your lender if you default; it ensures your lender will still get paid if you stop making mortgage payments.
PMI can cost between 0.3 percent and 1.15 percent of your loan annually. Depending on how much you borrow, that can mean thousands of dollars in extra costs until you can cancel your PMI.
But in certain situations, you can still come out ahead, even if you spend extra on PMI every month. Here are three situations where paying mortgage insurance could be worth it.
1. Home prices are rising
“Paying PMI is worth it when home prices are rising,” said Tim Lucas, managing editor of The Mortgage Reports.
If you want to buy in an area that is heating up but don’t have the 20 percent down payment saved, paying PMI allows you to get in now and reap the advantages of housing market appreciation.
“Saving for a down payment can turn into a real tail-chasing endeavor,” Lucas pointed out. “Home prices can rise faster than you can save up 20 percent of the increase.”
Consider a home that costs $180,000 right now. You need to save $36,000 for a 20 percent down payment. You have $20,000 saved up now, but it will take another two years to save up the remaining $16,000.
At the end of two years, that home is now worth $205,000. Now, you need $41,000 to hit that 20 percent down payment goal. Do you have that extra $5,000 to put down immediately? You might not. Even if you do have the spare cash to put down, you’ve already missed out on the equity appreciation by waiting two years to buy into a hot housing market.
Lucas said it makes more sense to pay the PMI when prices are rising so you can get into the house sooner. According to him, the average homebuyer misses out on $13,000 in lost equity each year by adhering to the advice of saving up a 20 percent down payment.
“A renter thinks nothing of his rent rising $100 per month, then skips home buying because of $100 per month in PMI,” Lucas said. “That money could have gone toward something useful like locking in predictable housing costs for the long-term.”
2. Mortgage interest rates are increasing
Another piece of the puzzle is the risk of rising mortgage interest rates. If you wait until you save up a 20 percent down payment and end up with a higher mortgage interest rate as a result, you could end up paying more over time in interest.
The Home Buying Institute expects mortgage rates to be above 5% by the middle of 2018.
|Home Price||Down Payment||Mortgage Rate||Monthly Payment||Total Interest Paid|
|Buy now with PMI||$180,000||$20,000||3.74%||$740 (+ $112 PMI for 111 months)||$86,428|
|Wait two years and avoid PMI||$205,000||$41,000||5.05%||$885||$113,747|
|*Monthly payments and total interest paid were calculated with a mortgage calculator. PMI payments were calculated based on an annual fee of 0.75 percent of the mortgage amount.|
This table uses numbers from the previous example. You can buy a home for $180,000 now with a $20,000 down payment or wait two years to put $41,000 down on a home that has risen in price to $205,000 and has a higher mortgage rate.
The table assumes that you will pay PMI for a little more than nine years, when the amortization schedule indicates you should have enough equity to cancel your PMI. Of course, if the home appreciates faster, you might be able to cancel your PMI sooner.
In this scenario, buying now with a down payment of less than 20 percent would save you money. Yes, your PMI payments would cost about $12,432 in total, but your interest savings over the life of the loan more than make up for it.
Plus, even when you pay for PMI, your monthly mortgage payment only totals $852. That’s less than what your monthly payment would be if you wait. The combination of higher home prices and a higher mortgage interest rate means that waiting could cost you.
3. You have other financial goals
Your mortgage isn’t just about the numbers. Perhaps you have enough to make a 20 percent down payment right now. But do you want to tie up that money in your home to save money on PMI?
Perhaps you want to pay off high-interest debt, or maybe you’d rather invest some of that money for your future. Matt Hackett, the operations director at direct mortgage lender Equity Now, said PMI gives borrowers more options.
“PMI allows a borrower to put down less than 20 percent and still get a conventional loan,” he pointed out.
Hackett said that some borrowers prefer to have that money available for other financial goals. Rather than letting that money sit in a bank account and then tying it up in the house, you could invest it and take advantage of higher returns.
Once that down payment turns into home equity, it’s less liquid; you have to get a home equity loan to access your money. If you put it toward paying down credit card debt, building an emergency fund, investing, or other goals, it’s quicker to access resources down the road.
“It comes down to how much someone values having money in the bank,” said Hackett.
Is mortgage insurance worth it?
When it comes down to sheer numbers, it may seem like paying PMI makes sense. But some of the scenarios above are based on future expectations. There are risks involved with committing to PMI now and hoping to reap the benefits later.
If the housing market crashes again, you might have to wait longer to realize the gains in equity appreciation. You might not stay in your home for 30 years or even long enough to get rid of PMI. Mortgage rates might not rise as much as expected.
In those cases, PMI could end up being an extra cost.
Making a 20 percent down payment results in a greater chance that you’ll have the capital to “cash out” when you sell your home. That capital can be used to help you move or put a down payment on a different house.
In the end, it’s important to consider your situation and figure out where the greatest risks are. Only then can you answer the question, “Is mortgage insurance worth it?” for yourself.
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