Private mortgage insurance (PMI) exists to protect the lender when a borrower defaults on their mortgage loan. PMI is typically only required for those who put less than 20 percent down on their mortgage, but with today's lower home values, borrowers who were able to skip PMI in their initial purchase may find that they aren't immune to this requirement when they apply for a refinance.
The reason? Their home's diminished value has reduced their equity to less than 20 percent, triggering the need for PMI on the new loan. PMI rates are based on the loan-to-value ratio as well as the creditworthiness of the borrowers, but even if you have good credit and have paid all your mortgage payments on time, low equity is still considered an increased risk on the loan.
But can PMI costs really impact your decision to refinance?
Refinancing with PMI
If you already pay PMI with your mortgage, your PMI premiums may change a little when you refinance into a new mortgage loan. The greater impact of paying PMI will be felt if you don't currently pay those insurance premiums.
But just because you might need to pay PMI doesn't necessarily mean you should avoid refinancing. You should still consult with mortgage lenders to make a comparison between your current mortgage payments and your scenarios for a new mortgage loan. You can also use a mortgage calculator to make your own estimates of various mortgage loan options.
Refinancing goals and PMI
Rather than dismissing the idea of refinancing because of the need for PMI payments, you should consider your options in the context of your long-term financial goals:
- Lower monthly payments. If you are refinancing in order to reduce your mortgage payments, you should crunch the numbers to see how PMI will affect your potential savings. Depending on a variety of factors, such as your home's loan-to-value ratio, credit score and whether you wrap your closing costs into a new mortgage, your principal and interest payments will vary. If you currently have a relatively high interest rate now, your payments could still be lower even with the addition of mortgage insurance.
- A shorter loan term. If your goal is to pay off your mortgage faster and you switch from a 30-year loan to a 15-year loan with PMI, your monthly payments will likely go up. However, as you repay the loan, your PMI premiums will end when your loan-to-value reaches 78 percent. So it may still be worthwhile to pay the PMI costs in order to reduce the amount of interest you are paying on your mortgage.
You may also want to compare your options for an FHA loan. All FHA loans require mortgage insurance and include both upfront and annual mortgage insurance premiums. Your lender should compare both a conventional loan and an FHA loan to see which loan best meets your goals.
While PMI costs can reduce your savings on a refinance, it's still worth your time to compare all of your options in the face of a new PMI requirement. While no one likes extra items on their monthly mortgage bill, your decision to refinance will likely depend on much more than one simple add-on.