PMI stands for Private Mortgage Insurance and it’s a form of coverage that a lender will likely require if you can’t offer a down payment equal to 20% of the home’s purchase price. Borrowers without that significant down payment are seen as riskier, so PMI protects the lender in the event that the mortgage goes into default and the home ends up foreclosed.
PMI can be a great tool because it opens the door to home ownership for people who haven’t been able to save up that 20% down payment. But it can also be expensive. The typically fee is between 0.5% – 1% of the mortgage annually. So, if you borrowed $200,000, your PMI costs would be between $1,000 to $2,000 a year. That’s an extra $84 to $166 every month added onto your loan payment!
That said, there’s a really straightforward way to minimize your PMI fees: save as much as possible for your down payment! Don’t let up on saving just because you’re not going to make it to 20%. Assuming payments are current, PMI only remains on the loan until the principle has been paid down to 78% of the original home value. If you start with a 5% down payment, you have to pay the principle down another 17% to remove the PMI. If you come to the table with a 10% down payment, that goes down to 12%. The more you can put down up front, the faster you’ll be able to remove the extra insurance costs.