Private Mortgage Insurance

 Private Mortgage Insurance

PMI, or private mortgage insurance, is an insurance policy that home buyers are required to purchase if their down payment is low. It is usually required of home buyers whose down payment is 20 percent or less of the property’s sale price or appraised value. This insurance was created by private mortgage insurers to provide protection for the lender in the event that the home buyer should default on the loan.

Private mortgage insurance has helped millions of people purchase homes, since people are able to purchase homes with smaller down payments than had previously been accepted. As home prices continue to soar, the ability to purchase a home with a small down payment has become even more important. PMI allows potential homeowners to purchase homes sooner, with as low as a 5 percent down payment. Also, it can help an individual qualify for a variety of mortgages.

The cost of private mortgage insurance varies according to the down payment and mortgage loan, but it typically equals approximately one half of one percent of the total amount of the loan. So, how exactly is it calculated? Let’s assume you purchased a home for $100,000, and you put $10,000 as your down payment. Your lender will multiply the remaining 90 percent by .005 percent. The result, $450, is your insurance premium, which is divided into monthly payments.

After a few years of paying on your mortgage balance, you should be in a position to stop making payments towards the premium. Keep track of your payments and contact your lender when you reach 80 percent equity, so that the policy can be cancelled. In 1999, a new law, the Homeowner’s Protection Act, was passed. This act requires lenders to notify you, the buyer, how many months and years it will take to pay off twenty percent of your principal. It is still a good idea to keep track of it on your own, however.

This same law also allows lenders to force certain buyers continue their PMI payments, all the way to 50 percent equity. This requirement applies to buyers classified as high risk borrowers. Some Federal Housing Administration loans may even require that home buyers acquire private mortgage insurance through the lifetime of the loan.

If the idea of paying for this type of insurance for years sounds unappealing, you’re not alone. Over the years, new ways of avoiding these payments—even when you don’t have the 20 percent down payment available—have emerged. One strategy commonly employed is to pay a higher interest rate on your mortgage. Some lenders will waive the private mortgage insurance requirement if the home buyer agrees to pay a higher interest rate. One advantage to this strategy is that mortgage interest becomes tax deductible, where the insurance premium is not.