Before buying a home, you should ideally save enough money for a 20% down payment. If you can't, it's a safe bet that your lender will force you to secure private mortgage insurance (PMI) prior to signing off on the loan, if you're taking out a conventional mortgage.
Private mortgage insurance, or PMI, is insurance coverage that protects the lender in case a borrower defaults on a home loan. Typically a lender will require you to pay for PMI if your down payment is less than 20% on a conventional mortgage. You can get rid of PMI after you build up enough equity in your home.
You should pay PMI upfront if: You have the extra savings to cover the premium cost. If you have extra cash to cover your down payment, closing costs and the extra premium expense, you'll end up with a lower monthly payment. Your closing costs are being paid by the seller.
It's nearly impossible to make that kind of return in the stock market, retirement account, or another financial instrument. PMI, then, can be viewed as an investment — a very sound one — and not a waste of money.
Down Payment Amount
A lower down payment means your regular mortgage payments are higher and it will take longer before you're able to cancel PMI. All of this increases the possibility of you missing a payment, meaning you may be charged higher PMI premiums.
The traditional way to avoid paying PMI on a mortgage is to take out a piggyback loan. In that event, if you can only put up 5 percent down for your mortgage, you take out a second "piggyback" mortgage for 15 percent of the loan balance, and combine them for your 20 percent down payment.
Taxpayers have been able to deduct PMI in the past, and the Consolidated Appropriations Act extended the deduction into 2020 and 2021. The deduction is subject to qualified taxpayers' AGI limits and begins phasing out at $100,000 and ends at those with an AGI of $109,000 (regardless of filing status).
Eliminating your PMI will reduce your monthly payments, giving you an immediate return on your investment. Homeowners can then apply the extra savings back towards the principal of the mortgage loan, ultimately paying off their mortgage even faster.
PMI Premium: The higher the PMI premium, the more likely the higher rate is a better deal. Premiums vary with the type of loan, term, down payment and other factors. The Rate Increment: The smaller the increase in the interest rate charged in lieu of PMI, the greater the advantage of the higher rate loan.
The Bottom Line. PMI is expensive. Unless you think you'll be able to attain 20% equity in the home within a couple of years, it probably makes sense to wait until you can make a larger down payment or consider a less expensive home, which will make a 20% down payment more affordable.
“In order to get your private mortgage insurance removed, you may need to be on the loan for a minimum of 12 months,” shares Helali. “After you've been on the loan for one year, the lender should automatically dissolve the PMI when you have 22% equity in the home.”
On average, PMI costs range between 0.22% to 2.25% of your mortgage. How much you pay depends on two main factors: Your total loan amount: As a general rule, PMI expenses are higher for larger mortgages. Your credit score: Lenders typically charge borrowers with high credit scores lower PMI percentages.
You cannot negotiate the rate of your PMI, but there are other ways to lower or eliminate PMI from your monthly payment.
There's no doubt that putting down greater than 20% will get a homebuyer a lower monthly mortgage payment. A large down payment lowers the overall risk to the lender of financing the home, and so they will reward the customer with a better rate.
One way to avoid paying PMI is to make a down payment that is equal to at least one-fifth of the purchase price of the home; in mortgage-speak, the mortgage's loan-to-value (LTV) ratio is 80%. If your new home costs $180,000, for example, you would need to put down at least $36,000 to avoid paying PMI.
Use a “piggyback loan” with 10% down and no PMI
This is a unique loan structure where the buyer needs only 10% down in cash. The buyer then takes out a second mortgage loan, which provides another 10% of the home's purchase price. So they effectively have a 20% down payment and do not have to pay mortgage insurance.
The deduction expired in 2017, then it was restored in late 2019 and retroactively applied to the 2018 tax year. The deduction was available for the 2020 tax year and extended through the 2021 tax year via the Consolidated Appropriations Act.
The only way to cancel PMI is to refinance your mortgage. If you refinance your current loan's interest rate or refinance into a different loan type, you may be able to cancel your mortgage insurance.
If you've owned the home for at least five years, and your loan balance is no more than 80 percent of the new valuation, you can ask for PMI to be cancelled. If you've owned the home for at least two years, your remaining mortgage balance must be no greater than 75 percent.
On April 28, 2021, U.S. lawmakers introduced the First-Time Homebuyer Act of 2021. The bill revises the IRS tax code to grant first-time home buyers up to $15,000 in refundable federal tax credits.
If you itemize your taxes, you can usually deduct your closing costs in the year in which you closed on your home. If you close on your home in 2021, you can deduct these costs on your 2021 taxes.
Yes; through tax year 2021, private mortgage insurance (PMI) premiums are deductible as part of the mortgage interest deduction.
Mortgage insurance is required on most loans when borrowers put down less than 20 percent. All FHA loans require the borrower to pay two mortgage insurance premiums: Upfront mortgage insurance premium: 1.75 percent of the loan amount, paid when the borrower gets the loan.