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When purchasing a home with a down payment of less than 20%, many borrowers are required to pay for Private Mortgage Insurance (PMI). This insurance protects the lender in case the borrower defaults on the loan. While PMI can make homeownership possible for many, it also impacts the overall closing costs of a mortgage.
What is Private Mortgage Insurance (PMI)?
PMI is a type of insurance that lenders require from homebuyers who put down less than 20% of the home’s purchase price. It is an additional cost that is added to monthly mortgage payments until the borrower builds enough equity in the home, typically reaching 20% equity.
How Does PMI Affect Closing Costs?
While PMI is often paid monthly, it can also be paid upfront at closing. This upfront premium adds to the closing costs, increasing the total amount due at settlement. The amount varies depending on the loan amount, the lender, and the specific PMI policy.
Upfront PMI Premium
The upfront PMI premium can range from 1% to 3% of the original loan amount. Borrowers may choose to pay this fee at closing or roll it into their mortgage. Paying upfront can reduce or eliminate monthly PMI payments, but it increases closing costs initially.
Monthly PMI Payments
If the upfront premium is not paid, borrowers will pay PMI as part of their monthly mortgage payment. These payments typically range from 0.3% to 1.5% of the original loan amount annually, divided into monthly installments. These ongoing costs also contribute to the overall closing expenses.
Managing the Impact of PMI on Closing Costs
Borrowers can explore options to reduce or eliminate PMI costs. Making a larger down payment to reach 20% equity is the most straightforward method. Alternatively, some lenders offer lender-paid PMI or allow for a single premium payment to avoid monthly costs.
Conclusion
Understanding how PMI affects closing costs is essential for homebuyers. While it can increase initial expenses, strategic choices and negotiations can help manage these costs. Being informed allows buyers to plan better and make confident decisions during the home buying process.