We’d crunched all the numbers. We’d submitted all the right forms. We thought we’d covered all our bases.

We were wrong.

When the mortgage broker at our bank called back to discuss our preapproval status, we assumed we’d qualify for the exact amount we’d calculated: $200,000. After all, our debt-to-income ratios were within the bank’s guidelines. But we’d overlooked one key element of just about all home loans these days: PMI.

PMI = Private Mortgage Insurance

My husband and I knew our finances could easily support the mortgage on a $200,000 home. We’d used a mortgage calculator to factor in all the odds and ends that go along with purchasing a new home:

  • Purchase price: $199,900 (seller pays 3% closing costs)
  • Yearly taxes: $2580 annually, or $215 a month out of escrow
  • Home insurance: $625 annually, $52.08 a month out of escrow

The FHA loan we were considering required us to put down a minimum of 3.5 percent in order to lock in an interest rate below 4 percent, although we have the liquid assets to be able to put down much more than that. However, we fell short of the 20 percent mark, which put us on the fast track for private mortgage insurance.

Why Do I Need PMI?

To be completely honest, I was insulted at the thought of having to take out PMI along with my home loan. After all, I wasn’t a first-time homeowner: my husband and I had never – not once – missed a mortgage payment on our first loan. In fact, we’ve never missed a payment on any loan, ever. We’re the types of people who pay off our monthly balances in full and on time, month in and month out. Add to that, we have perfect credit. Couldn’t the bank just trust us?

Apparently not. While foreclosure rates were down in 2011, banks are still reeling from the nearly 3.8 million foreclosures in 2010 alone. And although experts expect to see the housing market bottom out – at least when it comes to foreclosures – in 2012, they’re still not taking any chances.

Today’s PMI Rates

Factoring in private mortgage insurance to your monthly loan payments is a fairly simple process. In fact, my favorite mortgage calculator includes a spot for PMI. Here’s how it works:

  • It all depends on your down payment and the length of your loan. Traditionally, PMI rates are higher on 30-year fixed loans than they are for 15-year mortgages. For example, put down the 3.5 percent required by an FHA loan on a 30-year mortgage and you’ll be paying .90%; put down the same amount on a 15-year mortgage, and your PMI rate will be .78%. You can check out an estimate of PMI rates by clicking here.
  • The more you put down, the lower your PMI rate. Putting down an even 5 percent on a 30-year mortgage gives you a rate of .78%. But, if you increase your down payment even by a fraction of a percent – say to 5.01 percent – you’ll pay just .52%.

What Do The Numbers Mean?

How do you turn that .52% PMI rate into an actual dollar amount? You’ve got to factor in the amount of your loan. Let’s use my example: a $199,900 purchase price with a five percent down payment, netting me a total loan amount of $189,905 and a PMI of .78%:

[$189,905 (loan amount) x 0.0078 (PMI rate)] / 12 (months in a year) = $123.44 a month for PMI

But like I said, you can save a lot of money just by increasing your down payment by a small amount – and securing a lower PMI rate. For example, a down payment of 5.01 percent would only reduce the amount on my loan by $200; however, it would drop my PMI from .78% to .52%, saving me nearly $50 a month – that’s $600 a year! And since I’ll be paying PMI until the remaining balance on my mortgage loan hits 80 percent of my purchase price – in my case, the next seven to eight years – that $200 difference up front could save me thousands on the back end.

Avoiding PMI Altogether

Of course, my husband and I could avoid paying private mortgage insurance altogether, simply by putting 20 percent down on our mortgage. Banks consider that 20 percent mark the “magic number,” signifying your stable enough with your monthly payments and your loan’s balance for them to be fairly confident you’re going to pay your monthly mortgage and not walk away from the property.

We’ve considered that option. We’re fortunate enough to have the assets on hand to make that happen (or, we will once we sell our current house). However, we’re looking to buy a home that’s a “fixer,” and we want to pay for a lot of the immediate updates with cash. It’s sort of like robbing Peter to pay Paul, but we figure even paying $80 a month in PMI for a few years is a smarter choice than paying a higher interest rate on a personal or home equity loan.

Reader, do you or have you paid PMI on your home loan?