Can private mortgage insurance be beneficial?

When looking for a home, buyers often strive to avoid private mortgage insurance. While they'll get the satisfaction of building up equity in their property with each mortgage payment, they'll also experience the frustration of having a fee go toward the lender for several months or years.

Private mortgage insurance can be avoided at the outset by making a large enough down payment. Most lenders require that PMI be included if the buyer puts less than 20 percent down on their home purchase. However, some buyers may discover that it makes more sense to make a smaller down payment, keep more money in their bank account, and absorb PMI costs for awhile.

Lenders consider buyers who make smaller down payments to present a greater risk of default, so PMI is meant to minimize losses if this unfortunate circumstance occurs. Hal M. Bundrick and Barbara Marquand, writing for the financial site NerdWallet, say the monthly premium will help a lender recoup some of the money a buyer borrowed if they are unable to keep up with their mortgage payments.

The monthly cost of PMI is based on the outstanding loan balance as well as a variety of other factors. If you don't put down 20 percent of the purchase price but still pay a substantial percentage, a lender will likely consider you a lower risk. A strong credit score and a less risky loan type, such as a conventional fixed rate mortgage, will also put you in a stronger position. Lauren Sieben, writing for Realtor.com, says PMI premiums to vary substantially, from as low as about 0.3 percent to as high as 1.15 percent.

While PMI is usually added to your monthly mortgage payments, it can sometimes be charged in other ways. Dori Zinn, writing for the financial site Bankrate, says a lender may require it to be paid up front, or allow a buyer to pay some of the expense in advance and charge the remainder as a monthly expense.

It can take a long time to save up enough money for a 20 percent down payment, especially when home prices are rising. Leann Harms, writing for the financial site The Nest, says that while PMI is primarily designed to protect lenders, it can also help buyers achieve homeownership more quickly by letting them purchase a home with less money down.

The most obvious reason home buyers seek to avoid PMI is that it represents an extra cost that could otherwise stay in your bank account or go toward the mortgage principal. Yet PMI can also work as a tradeoff, allowing you to make temporary payments in exchange for saving more money at the outset.

Let's say you have $40,000 available and are looking to purchase a $200,000 home. You could use the entire sum for a down payment to avoid PMI, but it will take a long time to build your savings back up. You also don't want to deplete your bank account to the point where you won't have an emergency fund to meet unexpected expenses.

If you instead opt to put down 10 percent, it keeps $20,000 in your bank account. Sieben says these funds can then be leveraged for purposes such as paying down debts with higher interest rates than the PMI premium or investing in renovations that will boost the home's value.

PMI premiums tend to be fairly modest, especially when mortgage interest rates are low. If the above example resulted in a 0.75 percent premium based on the outstanding balance of $180,000, it would amount to $1,350 a year, or a monthly fee of $112.50. At this rate, it would take nearly 15 years before the amount paid in premiums exceeded the amount saved at the outset.

Moreover, PMI is only a temporary fee. Harms says a lender will automatically stop charging the premiums once you've paid off 22 percent of the purchase price through regular mortgage payments. You can also contact the lender when your regular payments reach 20 percent equity to ask them to stop charging you PMI, or if a reappraisal shows that your home has gained enough value to boost your equity to 20 percent or more.

If you decide to make a smaller down payment and pay PMI, make sure you can afford the monthly expense. Zinn recommends comparing the terms of different lenders and mortgage types. Since a larger down payment can cut down on your PMI premiums and how long they'll be charged, you can also consider reigning in the price range of the homes you're looking for or increasing how much you'll put toward the purchase, even if you keep the down payment under 20 percent.

Your circumstances may make PMI inadvisable. Sieben says premiums are likely to be higher if you have a lower credit score. Rather than shouldering these costs, you may want to take the time to build up your savings and improve your credit.

Lenders may also have options that don't charge PMI but don't require a 20 percent down payment either. Bundrick and Marquand say lenders may charge a higher interest rate instead of PMI, or offer an 80-10-10 loan that requires the buyer to cover half of the 20 percent down payment and take out a second loan for the other half.

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