Private mortgage insurance (or PMI) has gotten a bum rap over the years, but it's a necessary evil. PMI can let you buy a home when you don't have a large down payment, but you don't want to pay it if you don't have to. Learn about why you may need PMI, and how to avoid it.
Private Mortgage Insurance
What is Private Mortgage Insurance?
Private mortgage insurance (PMI) is protection for your lender, not you. If you are requesting a mortgage for more than 80% of your new home's value, PMI is insurance that will protect them from taking a big loss in the event of your defaulting on the loan. The 20% cushion gives the lender security in the event that the home's value declines or they have to sell it at a distressed price in the event of foreclosure.
Why PMI isn't all bad
Without PMI programs, most mortgage lenders would be reluctant to make loans without having large down payments from the borrower. With the safety net of PMI, lenders can offer mortgages to borrowers putting as little as 3% down. PMI has allowed many more people to become homeowners, and buy larger homes, than would otherwise have been possible.
What does it cost?
PMI costs vary, so if you need it, ask your lender if there are options that can reduce your cost. The amount of the loan and the amount of your down payment will affect the overall cost. Policies typically run about 0.5% of the loan amount in the first year, with payments falling as your payment history grows and you build equity in the home.
How to avoid PMI
Most home buyers look to avoid PMI if they can, since this is money that could go towards reducing their debt if it wasn't going to an insurance company.
There are two common ways to avoid having to pay PMI. One is to put more than 20% cash down on your new home. When this is not possibly, borrowers use vehicles called "piggyback" loans. This set up makes use of a second loan to reduce the amount of the first mortgage. The most popular type of piggyback is the 80-10-10. The borrower takes out a first mortgage for 80% of the value of the home, a second mortgage for 10% of the value of the home, and puts 10% down.
Ending your PMI payments
Since PMI is intended to reduce the lender's risk, it's only fair that this insurance end when the risk is no longer there. In 1999 the new Homeowner's Protection Act of 1998 (HPA), also known as the PMI Act, enabled homeowners who meet specified requirements to have their PMI canceled.
You have the right to request cancellation of PMI when your mortgage balance falls to less than 80% of the original purchase price or current value of your home. You also need to have a good payment history. However, your lender may require an appraisal to prove that the value of the property has not fallen below the purchase price and that you have not taken out a second mortgage like a home equity line of credit. Ask your lender about the terms of PMI cancellation and be prepared to make your request as soon as you qualify.
Your mortgage company must automatically cancel your PMI once your mortgage balance falls to 78% of the value of your home. But if your loan is delinquent, they can wait until the loan becomes current. For some high risk loans, the benchmark is 77%.
There is one more kicker for automatic cancellation of PMI. If your loan reaches the the halfway point, your PMI must be canceled. So on a 30 year loan, your PMI ends after 180 payments. This provision also requires that you be current on your loan payments.
Other Buyers Guide Topics
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Other Web Info
Information on the PMI Act from HUD.