I call PMI a necessary evil. Without it, banks wouldn’t lend to borrowers that don’t have at least 20 percent equity in a home. Most people that are aware of PMI aren’t aware of the payment options that are available, however. Most borrowers that have PMI pay it the traditional way, which is referred to as borrower-paid-mortgage-insurance (BPMI), where there is a temporary add-on to the mortgage payment. After twenty percent equity is achieved- something that typically takes around seven to ten years on average- it goes away. The equity position at the time of closing also largely impacts that timeframe.
Single-premium mortgages are offered at a discount because the entire cost of the PMI is paid in a lump sum at the time of closing. Basically, it’s prepaid and the companies offering and issuing the PMI provide this option at an overall lesser cost. I’ll provide an example to illustrate this, but keep in mind that every borrower may have a different PMI cost structure as it’s based strictly upon credit scores and equity positions.
Home value/price: $300,000
Loan amount: $285,000
PMI cost factor (traditional): .41%
PMI cost factor (single premium): 1.16%
The above data represents a potential buyer’s PMI cost comparison at a 5% down payment amount. The traditional PMI will be attached to the loan for about nine years at a cost of about $97 per month ($285,000 x .41% / 12). The total paid using the traditional method would be about $10,500 (monthly expense x 9 years of payments), and the cost of the single-premium is $3,306. That’s about a $7,000 cost difference!
So how is it paid? There are actually two options. It can either be paid at the time of closing or it can be financed. If it’s paid at closing it’s pretty straightforward as it’s a one-time cost added to the existing cost structure of the loan, but if it’s financed, it’s added to your loan amount. This way saves you from paying it at closing, but doesn’t increase your payment. However, the increase in payment is significantly less than the traditional PMI payment. Financing that extra $3,306 increases the payment by about $15 per month, but that’s $77 less than the traditional method.
Remember, knowledge is power, so if there’s one take-away from this post it’s to know how to maximize your buying power. Either you learn how you can pay less per month in PMI expenses or you know that by minimizing your PMI expense, you may be able to afford more, which can help you during a competitive seller’s market.