WHAT IS PMI? SHOULD YOU REFINANCE EVEN IF ADDING PMI?What’s PMI? PMI is the acronym for Private Mortgage Insurance. Private mortgage insurance came into play in the late 1950s as a response by conventional lenders to compete with low down payment, government-backed mortgages. Prior to PMI, conventional loans asked for a 20 percent down payment. That’s a lot of money, especially for the first time home buyer and a major reason why most first timers selected the FHA loan instead of a conventional mortgage. Conventional lenders couldn’t compete with low down payment loans. That is until the introduction of PMI.
In practice, borrowers purchase a private mortgage insurance policy and typically pay this premium each monthly along with the rest of the mortgage payment, taxes and insurance. The insurance premium covers the amount between what the borrowers put down and the 20 percent requirement. If the borrowers put down 10 percent, the policy would compensate the lender for the other 10 percent should the loan ever go into default. If the borrowers made a 5 percent down payment, the PMI policy would cover 15 percent of the sales price. There are also PMI policies where the lender pays for the premium and PMI policies that are rolled into the loan amount as well. The lender will provide all PMI options but the borrowers paying a monthly premium is the most common.
Is PMI a good thing? PMI over the years endured some bad coverage as an unneeded expense that added to the cost of the loan and increased the monthly payment. When monthly payments are higher, borrowers can borrow less money. PMI wasn’t tax deductible like a second mortgage might be, which was another good option. Both cases against PMI made perfect sense and for years, PMI companies made adjustments that attempted to compete with a second mortgage, the borrowers waiting to save up 20 percent down or getting a government-backed loan. Yet back in 2007 all that changed.
In 2007, private mortgage insurance did become tax deductible as part of the Tax Relief and Health Care Act of 2006. Since then, the deductibility has been extended. It’s important to note here to consult a tax professional for this and all tax questions but this one change in the tax code regarding PMI made a huge impact in consumer and lender acceptance. PMI is indeed a good thing because it provides borrowers with more options when financing a home. And the more options, the better.
Even if someone refinances an existing mortgage and the loan will be greater than 80 percent of the current market value of the home, it can still make sense to refinance and refinancing doesn’t jeopardize the tax deductibility of PMI. That simply means if the total payments of principal and interest plus PMI are still lower than the existing one, or the borrower is refinancing form an ARM into a stable fixed rate loan, it can be a wise choice. Just run the numbers with your loan officer and then decide.
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