Keller Williams Realty Elite

If you're in the market for a new home and your credit score is marginal, your private mortgage insurance, or PMI, rate might be hundreds of dollars higher per month than you expect.

Credit scores impact interest rates on all types of loans, but their effects reach far beyond loan rates, resulting in additional expenses that can run into thousands of dollars per year.

The sticker shock of a sky-high PMI payment is bad enough, but some borrowers don't find out that their PMI will add hundreds of dollars to their payments until they are sitting at the closing table.

Mortgage lenders require PMI on loans where borrowers are financing more than 80 percent of the price. Unlike other types of insurance, PMI is designed to protect the lender, not the person paying the premiums. There are ways to structure mortgage loans to avoid PMI, but because the effect of a poor credit score is so pervasive, the costs of alternative transactions can equal the cost of higher PMI.

"If your credit score is in a range where you fall into a subprime category, you will pay a higher PMI rate," says Bob Walters, chief economist at Quicken Loans, a lending company. "This is not just based on your credit score, but it is a basic principle of risk management. If your loan is deemed as riskier in terms of your ability to repay, you will pay more in interest on the loan, PMI and in your closing costs.

"Basically, your terms will be more restricted than a borrower with a higher credit score because the company that is lending the money needs a higher rate of return to compensate for the increased risk."

Most Americans have credit scores that fall between 600 and 800; the range of all FICO scores is 300 to 900. However, those with credit scores below 620 are frequently categorized as "subprime borrowers," meaning that creditors view them as more likely to default on loans. They get hit with higher interest rates and fees on virtually every loan, from mortgages to car loans to credit cards.

PMI premiums
A borrower's credit score is only one of the factors that goes into the underwriting of PMI loans.

Other determining factors:

• Size of the down payment. Your PMI premium will be higher if you put down 5 percent, versus putting down 15 percent (this is also known as the "loan to value ratio"). • Potential for property appreciation. Your premium might be higher if you live in a city with declining property values. PMI companies monitor real estate prices and the economic trends that affect them as they set PMI rates. • Type of loan. The rate can vary depending on whether you are getting an adjustable- or fixed-rate mortgage or an interest-only loan. The riskier the loan, the higher the PMI. • Interest rate. A higher interest rate can, and usually does, mean a higher PMI rate because borrowers with poorer credit scores are frequently offered higher interest loans that carry higher PMI payments. • Borrower occupancy. If you are borrowing to purchase an investment or rental property, your premiums will be higher than if you borrow for a home you plan to occupy.

Types of PMI
There are two types of PMI: borrower-paid and lender-paid. Borrower-paid PMI is by far the most widely used, but PMI companies are touting lender-paid as an alternative to piggyback loans, which are popular with borrowers.

Here's a rundown of PMI options:

• Borrower-paid PMI. The traditional type of PMI. The loan premium is added to the mortgage payment and the mortgage company transmits the PMI payment to the insuring company. • Lender-paid PMI. The payments are wrapped into the overall loan rate so you don't make a separate PMI payment. Instead, you pay a higher interest rate and the lender pays a portion of your overall payment to the insuring company. The advantage of this type of PMI is that you can deduct the mortgage interest from your taxes. PMI isn't deductible. • Piggyback loan: Named because a second mortgage is "piggybacked" onto the original mortgage loan, a piggyback mortgage is a second mortgage that closes simultaneously with the first. There are variations, but a popular product is the 80-10-10 loan, where the consumer takes out an 80 percent first mortgage, thus avoiding PMI, a 10 percent second mortgage and pays 10 percent as the down payment.