Private mortgage insurance (PMI) is an additional monthly fee lenders charge because you are considered a higher-risk borrower. PMI is to protect the lender not the borrower, and it cost you between .3% and 1.5% of your original loan balance every year. If you are unable to pay 20% of your new home’s cost, you will probably get slapped with PMI.
Admittedly, I am not a big fan of PMI, and I often get questions about my hesitancy toward taking a mortgage with PMI. And while I will not say that there is no scenario in which someone should take PMI, avoiding PMI is the best scenario. And I do believe there are real reasons to be concerned if you considering taking on a mortgage that includes PMI.
Let’s take a look at four reasons to be concerned about PMI:
1. PMI is more expensive. This one is obvious. If you have the 20%, it is cheaper to put the 20% down than to take on PMI. This is true for PMI or Lenders Private Mortgage Insurance (LPMI), where the lender increases the interest rate instead of tacking on the PMI monthly payment. If you have the 20% needed to avoid PMI, use it.
2. PMI may indicate that you are not in the best position to buy a home. This one comes straight from the banks. The reason banks include PMI is because they view you as a risky borrower. Based on their statistics, those who cannot put down 20% are more likely to default than those who can put down 20%. There are many factors why you may not have the money to avoid PMI—debt, inability to save, or maybe you are simply just now starting out on your own. Whatever the reason, PMI should cause you to pause and ask, “Am I really in the position to purchase a home?”
3. PMI may indicate that you are buying a home that is too expensive. Homeownership expenses are much more than just a mortgage payment. There are several other costs to consider before purchasing a home. One of ways to possible avoid PMI and reduce the level of these other expenses is to purchase a less costly home. So when you see PMI, you should ask yourself, “Do I really need to buy a house that costs that much?”
4. PMI is often taken because of an assumption of home appreciation. I always get concerned when I hear someone say that they are not worried about PMI because their house will appreciate, and they will be able to get out of it soon. If 2008 taught us anything, it is that we cannot rely on home appreciation to fix our financial woes. I hope it happens, but I do not recommend making a decision based on it.
We have all heard this saying—Just because you can doesn’t mean you should. Just because you can purchase a home doesn’t mean you always should.
How do you know you are ready for homeownership? Here are the three questions which you should be able to answer “yes”:
Do you plan on living there for at least 5 years?
Will your mortgage payments be less that 30% of your after-tax pay?
Do you have at least 20% for a down payment?
Homeownership is a good thing. It is a long-term strategy to free up future cash flow. But a mortgage with PMI should cause you to pause and reconsider your financial health and the cost of the home you are about to purchase. Because sometimes the best way to move forward in your financial health is to wait.