Reasons to Avoid Private Mortgage Insurance
Private Mortgage Insurance or PMI sounds like a perfect solution to own a house even if you haven’t saved enough cash to pay 20% down payment. It makes you less of a risk to the lender while protecting the lender in case you default and can’t pay off your debt. But is it really a perfect solution? Is it a win-win solution for both parties? Are there some flipsides we fail to notice immediately but may feel the impact in the long-term?
Consider the following factors if you are planning to pay PMI and make an informed decision on whether you should avoid private mortgage insurance altogether or not.
1. Additional expense per month: Private mortgage insurance would annually cost you anywhere from 0.5% to 1% of the entire amount you have borrowed. For example, if you have taken a loan of $150,000 and if your PMI fee is 1 percent, you will end up paying $1,500 paying per year. This will amount to paying an additional $125 monthly. This amount is as good as paying for a car loan. In addition, your PMI will continue until you are able to accumulate a 20 % home equity. This could take years and it only means you are giving away a great deal of money. If this amount is carefully invested in a better scheme such as in mutual fund, it is bound to give you good returns over a period of time.
2. PMI may not be tax deductible: Private mortgage insurance is tax deductible but only up to a limit. If you are married, filing jointly and your combined income is less than $110,000 per year, you are eligible for deductions. Also, if you are married and filing separately, your annual income must be less than $55,000 to be able to claim the tax deductions in the PMI payments. This implies that if your combined income is just a little above the mentioned limit, you will not gain from the tax benefits. For homeowners who are considered just above this limit, it is advised to pay a larger down payment. This will at least help them to achieve deductions on the interest on the loan.
3. Only the lenders benefits: So the word insurance gives you comfort thinking that your spouse or children will receive compensation if something happens to you? Well, it must be noted that the only party that benefits from the PMI policy is the lender. All the proceedings will go to the lenders directly and not your lawful heir. While you are making the monthly payments, it is the lender who is receiving the benefit of mitigation from the risk, if at a certain point you can no longer pay your monthly payments to pay off the loans. You will receive no benefit or risk mitigation from this policy.
4. PMI is difficult and complicated to cancel: While you can request your lender to cancel the PMI once your equity reaches 20 % (as per the Federal Homeowner Protection Act), it is still a slow and tedious process – taking up to several months depending on the steps required to complete the formalities. Usually, you will be required to furnish a formal written request to your lender to ask him to cancel the PMI. You will also be required to receive your home appraisal before you can get your PMI cancelled.
Want to know what are different options to get your PMI cancelled? To get more insights into PMI, read What is PMI and how does it work?
Is there a good news?
Yes, as mentioned above PMI is tax deductible if you are earning less than $110,000 per year as a couple. This deduction translates in to considerable cost savings. Also, there is an option to pay an upfront amount for PMI at the beginning of your mortgage plan and it doesn’t need to be worked into your monthly payments. In some cases, your lender may even offer you a discount for paying an upfront PMI. You can also leverage the option of paying a one-time additional payment towards the remaining loan amount. And most importantly, it is the only option to own a home if you don’t have enough cash stashed up to put down for a 20 % as a down payment; unless you want to consider FHA loans.
Considering FHA approved loans? Read Things to Know Before Applying for FHA Loan.