Private Mortgage Insurance: When It Makes Sense to Pay
NEW YORK ( MainStreet) It's practically gospel: make your mortgage down payment large enough that you won't have to pay the dreaded private mortgage insurance.
But there are times paying PMI is better than the alternative. A period, like today's, of low home prices and bargain-basement mortgage rates can be one of them for some buyers.
PMI is insurance to protect the lender if you stop making mortgage payments. It's charged if your down payment is less than 20% of the home's value, typically your purchase price. If your equity is larger than that, odds are the lender could sell your home in foreclosure for enough to cover your debt, so PMI is not required.
PMI charges depend on the size of your mortgage, down payment and borrower's credit score . With a typical home selling today for $212,100, a borrower with fair credit paying 5% down would be charged about $154 a month for the PMI premium, according to HSH.com, the mortgage data firm. The rate might be only $76 for a buyer with very good credit and a 10% down payment. (HSH has a PMI payment calculator here.
Given that the monthly payment for that home would probably be around $1,000, an extra $154 a month would be a sizable premium, boosting the payment by 15.4%.
So under what circumstances should the PMI be considered a worthwhile investment?
One of the clearest, HSH notes, is when the home purchase can't otherwise be made. That could mean paying rent longer, or watching home prices or mortgage rates rise while you wait to accumulate a down payment large enough to escape PMI. In the past year, home prices have gone up about 12% nationwide and more in some hot markets, though many experts think price gains will slow. Mortgage rates have inched up since spring, though they've been fairly flat this fall.
Also, PMI is not a life sentence. Under federal law, you have a right to get it canceled once your equity current home value minus remaining mortgage debt reaches 20%. Rising home prices could get you to that point fairly quickly. Even if increases in home prices are modest, over a number of years your monthly mortgage payments will whittle your debt until you reach that 20% threshold. In the meantime, your PMI payment will likely be deductible on your federal tax return.
To rid yourself of PMI, you may have to spend several hundred dollars to have the home appraised, but the savings on PMI premiums could quickly offset that cost.
Living with PMI can also pay if making a 20% down payment would leave you with too little cash for emergencies, HSH adds.
And even if you have plenty of cash for a 20% down payment, you may find an investment you prefer. Be sure to do the math, though. If adding $10,000 to your down payment would save you $100 a month in PMI, that $1,200 a year would be a 12% return on the "investment."