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Paying PMI isn't as bad as you think

 

Consumers don't always see the benefit of private mortgage insurance (PMI) since the insurance protects lenders rather than borrowers. PMI is required for home purchases with a down payment of less than 20 percent and for a refinance when the loan-to-value ratio is greater than 80 percent.

"PMI makes a lender more willing to take on the risk associated with less home equity since the insurance will reimburse the lender if the borrower defaults on the loan," says Tim Mislansky, senior vice president for Wright-Pratt Credit Union in Fairborn, Ohio. "When you pay PMI, you're trading the payments for the ability to buy the home with less cash."

PMI costs

A 20 percent down payment is just not realistic for a lot of people, says Joseph Montanaro, a certified financial planner with USAA in San Antonio.

According to the NAR, the national median home price in August 2013 was $212,100, which would require $42,420 for a 20 percent down payment. If you saved $200 per month, it would take you more than 17 years to save for a 20 percent down payment, says Mislansky.

Paying a few hundred dollars in PMI for a few years allows you to buy a home and build equity rather than paying rent for years while saving for a bigger down payment, says John Clifford, senior vice president of commercial operations for U.S. Mortgage Insurance at Genworth Financial in Raleigh, N.C. PMI payments vary according to the size of your loan balance, the percentage of your down payment and your credit score, he says.

This chart demonstrates how your down payment and credit score dictate your monthly PMI cost. (Calculations were done via HSH.com's PMI calculator. They assume a 30-year loan at 4.21 percent and a purchase price of $212,100):

Credit Score

Down Payment

Monthly Premium

Fair credit: 680 to 719

5 percent: $10,605

$154

Very good credit: 720 to 759

5 percent

$110.82

Fair credit

10 percent: $21,210

$97.04

Very good credit

10 percent

$76.36

"Other factors such as your debt-to-income ratio only impact your eligibility for PMI but not the amount you'll pay for it," says Clifford.

5 reasons to pay PMI

No. 1: Keep your cash.

"It doesn't make sense to buy a house with a 20 percent down payment if that's all the cash you have," says Montanaro. "You need an emergency fund even more when you move into a house, because otherwise you could end up running up credit card debt to pay for repairs." There are a lot of 5- and 10-percent-down options out there today, he says.

No. 2: Mortgage rates are low.

"A lot of people want to take advantage of low mortgage ratesand buy before they rise," says Jeffrey Taylor, managing director of Digital Risk, a mortgage processing service provider in Maitland, Fla. "You can get into a house for a lot less in the long run if you buy now while rates are low rather than wait to save for a 20 percent down payment."

No. 3: Buy before home prices rise.

You can build equity faster if you buy when home prices are rising, says Taylor. But if you wait too long, your purchase may be delayed because your loan amount and required down payment will be higher.

No. 4: Take a tax deduction.

"In many instances you can save $200 to $400 per year on your taxes by deducting your PMI payments," says Clifford. "However, there are income qualifications so PMI is only fully deductible if your income is at or below $100,000" (if you file taxes as a single person, head of household or married filing jointly).

No. 5: You can cancel it.

By law, your PMI will automatically end once your mortgage balance has been paid down to 78 percent LTV, says Taylor.

According to HSH.com's PMI calculator, it will take a little more than nine years to eliminate PMI with a 5 percent down on a $212,100 home with a 30-year fixed loan at 4.21 percent, seven years with 10 percent, and less than five years with 15 percent down.

If home values have gone up since you purchased, Taylor recommends getting your home appraised to perhaps eliminate PMI even earlier.

"PMI shouldn't be the driver of your decision of when to buy a home and how much to spend, but it should be part of the calculation," says Montanaro. "If you need PMI, that should just be part of your budget."

About the author:

Michele LernerMichele Lerner, author of "HOMEBUYING: Tough Times, First Time, Any Time", has been writing about personal finance and real estate for more than two decades for a variety of publications and websites including The Washington Post, The Motley Fool, Investopedia, Insurance.com, HSH.com, SavingsAccount.com, National Real Estate Investor magazine, The Washington Times, Urban Land magazine, NAREIT's REIT magazine and numerous Realtor associations.

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