The Dirtiest Word in Home Buying: “PMI”

Everyone has an Auntie, Dad, or Boss that has railed against the evils of PMI. “It’s a scam! You’re throwing money away! Whatever you do, make sure you don’t have PMI!” In my decade plus of mortgage lending, I have found that PMI, or Private Mortgage Insurance, is often one of the most misunderstood elements of financing a home. The result is that many potential homebuyers needlessly miss out on amazing opportunities.

First, What is “Private Mortgage Insurance”?

Mortgage lending is driven by limiting risk to the bank. That said, everything involving your mortgage — underwriting guidelines, down payment requirements, interest rate pricing, loan programs, etc. are all geared towards insuring that the loan will be repaid. One of the “risk factors” banks look at is the amount of down payment a prospective buyer has available to put down on a home. The thought being, the greater “skin in the game” for the buyer, the less likely they are to walk away from a mortgage and leave the bank holding the bag.

At some point (and don’t ask me the history of this), a 20% down payment became the baseline for lenders when determining risk of repayment. Not wanting to exclude a significant portion of otherwise solid buyers, lenders began requiring an additional insurance policy (aka Private Mortgage Insurance) to be paid by the buyer to off-set the additional risk incurred to the bank by allowing a smaller down payment.

How Does PMI Work?

Generally speaking, when putting less than 20% down, the lender will shop rates with a multitude of companies offering PMI. The pricing of PMI is driven by many factors — credit score, amount of down payment, debt-to-income ratio, location of the home, type of home, etc. Traditionally, the premium is paid by the buyer monthly (rolled into their total mortgage payment) until they reach a 20% equity position. Within the last 10 years, companies have started offering single-premium MI, which is paid one-time, up-front at closing, or financed. They’ve also rolled out “Split-premium MI”, which has a smaller up-front MI premium paid at closing and a lower monthly premium paid until that magic 20% equity position.

Why Would I Ever Pay PMI?

At first glance, it seems like paying PMI is just throwing money out the window. After all, it doesn’t insure YOU, it insures the bank. To that I say, you’re right (to a degree). It is an additional cost to the buyer. HOWEVER, PMI also allows most buyers to enter into homeownership much, much sooner than they could if they waited and saved for a 20% down payment. Consider a hypothetical scenario: a couple wants to purchase a $750,000 home in Kona and has $50,000 saved. Let’s also imagine they have the ability to save $12,000/yr. Taking their boss’ advice, it would take just over 8 years to save the additional funds to put 20% down. In the meantime, the market continues to appreciate, they continue paying their landlord’s mortgage, and that $750k home will cost them $850k (if they’re lucky!).

Or, that same couple could put 5% down now, pay the $200/mo (est) PMI, take advantage of the tax benefits of homeownership, and build wealth through the appreciation of the home!

What Should I Do?

The best counsel I can offer to prospective buyers is to connect with a great mortgage lender that can model out different scenarios and options. For some, it does make more sense to wait and put more money down. For others, they’re actually positioned way stronger than they even thought. A great lender understands how to best structure PMI and will model out not simply your payment, but how your mortgage fits within your overall financial plan.