What is PMI and Mortgage Points

When you begin the process of buying a home, with little debt, and an outstanding credit score, you might qualify out of the 20% down payment. Even if you skip the down payment, they (the bank) will get you somewhere else. It’s best to be ready for it.

One way to compensate for the down payment is to increase the cost of your Private Mortgage Insurance (PMI). When you come into the bank to essentially buy mortgage points and walk out with a lower credit score, this whole process might begin to take a turn to the unknown.

So before you sign your name, be sure to completely understand how these two concepts actually work.

What is PMI, and how that no, or low, down payment will cost you

The mortgage company makes you get insurance to protect them if you happen to default on your loan. Typically you will have this insurance until a specific date, or until your loan reaches somewhere around 78% to 80%. This is how the lender will benefit if you do in fact default.

The cost of the insurance is based on the size of your down payment and your credit score. It can also be anywhere from 0.03% to 1.5% of the total loan amount. For instance, if you borrow $200,000 with a 1% PMI rate without a down payment that will cost $167 a month. 

PMI insurance used to be tax-deductible for certain tax bracket which would diminish the impact of this cost. It’s possible the current tax deduction on mortgage insurance payments will be extended, but don’t take it for granted.

Even though you’ve reached that magic number to stop [paying PMI, it doesn’t just go away. You must request the cancellation in writing and have paid your payments on time. You might also be forced to pay for an appraisal to prove the value of your home, or show proof there are no liens your house.

If you meet all those requirements, your lender must cancel the PMI.

Mortgage points and a low interest rate

Did you think there was only one hidden cost? Of course there’s a second; mortgage points can chance the entire structure of your loan. There are two types of mortgage points: discount points and origination points. One is no better than the other, and 1 point is equal to 1% of your loan.

Discount points are basically there to help you prepay the interest on your loan. You as the borrower, have the option to pay for additional points to lower your monthly payment. These are typically for people who plan to stay in their home for a while. Be sure to know when you are scheduled to break even by recovering the cost of doling out those thousands upfront.

If you are willing to pay for those, you may want to put those thousands toward your down payment to reduce your monthly PMI payments.

Origination points are used to pay for the administrative costs of getting a loan. The number of points assessed can be affected by your credit score, but can usually be around 1 point or 1%.

Discount points are tax-deductible because it’s going toward the interest on your loan, origination points can only be deducted if they were used to obtain the mortgage, and not cover the closing costs.

There are still plenty of costs even if you escape without a down payment and a great interest rate. The most important thing you need to know is everything about the process. You can really screw yourself over without knowing every detail and how it works. It’s a financial obligation to yourself.

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