Now that you've decided to buy your first home, you'll want to understand what Private Mortgage Insurance (PMI) is. Some home buyers will need it, others won't. Let's explore why it might apply to your first home purchase.
PMI is needed when you use a conventional mortgage loan to buy a home and can only pay a portion of the 20% down payment. PMI is designed to protect the lender if you default on your mortgage loan (ex. in the event of a foreclosure).
The amount you pay in monthly premiums (PMI payments) is dependent upon the amount of your down payment, your credit score, and insurer. Even if you can only afford a 10% down payment, you're off to a good start and will be able to get into a home sooner rather than later.
PMI is attached to your monthly mortgage payment and it is not permanent. Let's say you were approved to buy a $300,000 home and you can only afford a 10% down payment. You would end up paying $30,000 at closing for the down payment and would be required to have PMI.
PMI will cost anywhere from 0.5-5% of the original amount of your mortgage loan each year. If your loan amount is $270,000, after your down payment, you would pay approximately $112.50/month in PMI. Whether you think that's a lot of money or not, consider how long it would take to save for a 20% down payment ($60,000 using the previous example). Paying a little bit each month for PMI isn't looking so bad, is it?
Early I mentioned you won't have PMI forever. When you pay down the balance of your mortgage to 80% of the home's value, you can ask your insurer to cancel PMI. At 78% of the home's value, your insurer is required to cancel it.
As you can see, having PMI isn't a big deal and it will help you purchase a home sooner rather than later. Fortunately, as you're paying for it you're building equity in your new home. In addition, if the value of your home appreciates, the return on your investment increases as well.
To learn more about PMI and other types of loans that require it, talk to your real estate agent, lender, or check out The Insider's Guide to Home Finance. If you don't want to read the whole article, you can skip to the PMI section. We don't mind.