The Additional Cost of PMI and Mortgage Points to Home Buying
Last Updated: August 15, 2017
According to a recent study, buying a home is the number one most stressful experience in life. Can you believe buying a house beats out divorce, getting fired, or filing for bankruptcy? The U.S. Census calculated that the average person in the United States can expect to move 11.7 times in their lifetime. You would think with all of that moving we would get used to it — guess not.
Probably the most stressful part about buying a house is the lack of understanding when it comes to all the costs that add up in the mortgage loan — over and above the actual cost of the home. After you finally come to an agreement on the price with the seller, you think that is it but guess again, there are all kinds of different expenses that will come into play. The more you know about these fees, the less stress you will feel during this whole transaction. So, let's go over some of these costs and give you the much needed information regarding PMI and mortgage points.
What is Private Mortgage Insurance or PMI?
Private mortgage insurance, PMI, is designed to protect the mortgage company should you default on your loan. When you apply for a mortgage, the lender wants to make sure your home will have enough equity to pay off the loan balance should you default and go into foreclosure. Private mortgage insurance is an actual insurance policy issued by an insurance company that benefits the lender. If a home goes into foreclosure and the lender is not able to recoup the outstanding balance by selling the home, the insurance company that issued the PMI will pay the lender the difference.
PMI is called "private" because it is only offered to private companies and not government agencies such as FHA or VA mortgage programs. Government backed loans have their own version of PMI.
To determine whether or not you will be required to have PMI when you buy a new home, the lender looks at the amount of your down payment compared to the sales price to determine your loan to value (LTV) ratio. So if you purchase a home for $200,000 and put $20,000 down, your loan to value ratio is 90 percent. Typically, if your loan to value ratio is more than 80 percent, you will be required to pay PMI. You may also be required to carry PMI if you have poor credit, even if your LTV is 70, 60 or 50 percent.
Now, once you have reached a loan balance of 80 percent, don't think the PMI is going to magically disappear. You have to actually request a cancellation in writing and you have to be in good standing with your payment history. In addition, you may also have to pay for an appraisal to substantiate the current value of the home and submit proof you do not have any liens on the house.
The good news is if you have reached 78 percent LTV and your payments are up to date, your lender must automatically cancel the PMI.
Mortgage Points — Buying Down a Lower Interest Rate
Here is another monkey wrench that gets thrown into the entire home buying process - mortgage points. You will hear real estate agents and loan officers toss around terms like "discount points" and "origination points" as a matter of fact when you have no idea what in the world they are talking about. Before you venture down the road of home ownership, make sure you have a clear understanding what these words mean and what they will mean to you financially. Discount points and origination points are both equal in value - one point equates to one percent of the loan amount.
Discount points are a way of prepaying the interest on your loan. As the borrower, you have the option of paying these additional points to lower your monthly payment. If you plan to stay in this house for a number of years, buying these points is a great way to lower your monthly payment. Word to the wise, it is important to calculate when you will break even and begin to recoup the cost of this upfront cost. You might also want to consider if maybe the money would be better used as a larger down payment to possibly eliminate PMI payments.
Origination points might also be known as origination fees and are used to pay the administrative costs for acquiring a loan. The number of points assessed depends on your credit score and they usually are around one point or one percent, depending on the lender. Discount points are tax-deductible because they cover the interest on the loan. Origination points are only tax-deductible if they are used to obtain the mortgage and not to cover other closing costs.
The bottom line is that there is more to consider when getting a mortgage than just the down payment. The first hurdle to clear is getting a loan with a great interest rate but once you get over that, there are still plenty of other mortgage costs to consider. It is imperative you understand all the possible costs that could be thrown at you during the closing process of a loan. And, you need to make sure you have funds available to cover any of these unexpected costs. Make sure you are talking to your loan officer and getting as much information as you can before you sign on the line. This little bit of extra work on your part will pay off in the long run by saving you money in interest and fees when you buy a house.