Is PMI Insurance Necessary?

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Your Question: What Is PMI and is it Necessary?

Professor Tate Answers: 

 

To understand this question better, it is important to define some terms, especially for those who are encountering this term for the first time. What is PMI?

PMI stands for Private Mortgage Insurance. When you plan to loan money for your mortgage, the lender requires that you have a private mortgage insurance for loans with loan-to-value (LTV) percentages greater than 80% ( the formula for this is: mortgage amount owed / appraised value of your property). This is a way to protect lenders from borrowers that might end up filing for default on your loan due to inability to pay. The lender, in this instance a private bank, requires PMI if the buyer has a down payment less than 20% of the value of the home. 

PMI costs range from 2% to .25% of the balance of your loan per year. So depending on you down payment, how long your loan term is and your credit score, your risk factors will vary. The greater the risk factors are, the higher you will have to pay. Again, the principle behind this is to protect your lenders given the risk your profile poses. The worry of homeowners is that this was a recipe for a cycle of debt. The more you borrow, the more they have to pay since the PMI is a percentage of the loan amount.

Now, in the advent of Home Affordable Finance Program or HARP, borrowers are given more leeway. The program allows homeowners with higher LTV to avail of refinancing assistance through the Federal Housing Administration (FHA) loans. This was a way for the government to save those nearly “underwater” homeowners to finance their homes. 

Now to answer the question, is PMI insurance really necessary? It depends on what kind of borrower profile you have. Given that the FHA loan allows people with more than 20% equity in their homes to avail of HARP, while PMI only applies to conventional loans through the private banks, whether PMI is necessary for you depends on your borrowing status.

If you have sufficient money for down payment of the property you wish to buy, then you should stick to the conventional loan with the PMI. You should sit-down with your mortgage broker and discuss this with them so you can see the numbers clearly. The reason for this is that the FHA loan, while credited for being more flexible, can in the long run entail more costs. While it allows for down payments that can go as low as 3.5%, and it has less stringent guidelines than the conventional loan, it does not come without risks. 

But if you don’t have at least 5% for a down payment, and your credit score is low, then the FHA loan might work best for you. Whereas in a conventional loan, you have to pay for your mortgage using your own savings, the FHA loan is more lenient. You can pay through other people’s dole-outs. If you also went through bankruptcy or foreclosure, whereas the conventional loan would not qualify you until two years have passed, the FHA loan would. 
There are various benefits to both sides. The risks and gains would really depend on how well you understand your current financial profile. 

You asked, now you know!

-Professor Reel S. Tate 

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