What is PMI and Why Would I Have to Pay It?

Photo by coasttocoastlending.com

PMI or Private Mortgage Insurance is a term that lenders use with buyers and many of our clients ask us to explain it. (But our local lenders here in Oxford do a pretty great job of doing just that!) Here’s a great realtor.com article that helps to explain the details of PMI and why you would have to pay it.

The loan-to-value ratio (LTV) is one of the most important factors when buying a home and applying for a mortgage. The LTV ratio is a measure comparing the amount of your mortgage with the appraised value of the property. The higher your down payment, the lower your LTV ratio. Mortgage lenders use this ratio to determine the risk level they face when loaning money.

Many lenders require that borrowers have an LTV ratio of 80% (or lower) before they approve a conventional loan. This essentially means that the buyer needs to make a 20% down payment. For example, let’s say you have a contract for a $250,000 home (and the home appraised at $250,000) and you put down 20% ($50,000). Your loan would be $200,000, which is 80% LTV. You would not have to pay PMI.

There are many different loan types and many lenders that do not require you meet that 80/20 LTV ratio to get approved for a loan. Many buyers today do not have extra cash lying around for a large down payment. So is paying PMI the end of the world? No. I purchased my first home in 2006. I was a school teacher and there was no way I could pay 20% down. I paid PMI the entire time I lived in that home. It does make your monthly payment higher, but it is do-able. Just be smart and look at homes in a lower price range.