What You Need To Know About Private Mortgage Insurance
If your down payment on a home is less than 20 percent of the appraised value or sale price, you must obtain Private Mortgage Insurance, known as PMI, with your lender. This will enable you to obtain a mortgage with a lower down payment because your lender is now protected against any default on the loan. Private mortgage insurance is required for most people who seek mortgages every year, and is required by the mortgage company if you can't afford at least a 20% down payment on your home.
Most people don't understand PMI. For example, most people don't even realize they can cancel their private mortgage insurance at a certain time. Read to learn more about PMI so you can be prepared.
Who Needs Private Mortgage Insurance?
Private mortgage insurance isn't required for everyone, but most mortgagees (buyers) have it. Unless you are putting a substantial amount of money down as a down payment, it is typically needed for every buyer. Your mortgage company assures its investment in you by requiring private mortgage insurance per month in addition to your principle & interest payments. You can read your mortgage agreement to find out how long you have to carry it.
How Large of a Down Payment Do I Need to Avoid Private Mortgage Insurance?
Most mortgagors (a.k.a lenders) only require private mortgage insurance if you put less than 20% down on your home. Statistics have shown that people who put less than 20% down are more likely to default on their mortgage, so rest assured that this number wasn't pulled out of thin air. The theory is the more money a buyer invests into their home, the more "skin in the game" they have, and will be more diligent to make their mortgage payments so they do not lose their home that they invested so much money in. Agree with it or not, the mortgage industry is unlikely to change this anytime soon.
Why is Private Mortgage Insurance Necessary?
The mortgage company uses the private mortgage insurance to pay for the loan if you default. In other words, if you fail to make your monthly mortgage payments, the insurance company will reimburse the mortgage lender for their loss. Because so many home owners default on their mortgages, this is a necessary insurance policy for the mortgage company. If you had an investment worth 100's of thousands of dollars, wouldn't you want to protect it against loss?
How Can I Shop Around for the Best Private Mortgage Insurance Rate?
Unfortunately, you can't. Lenders work with national private mortgage insurance companies to determine the mortgage insurance you will be charged depending on credit score, loan to value ratio, etc. The good news is that most private mortgage insurance is about the same price per month; the bad news is that you don't get a say in the matter.
When Can I Drop My Private Mortgage Insurance?
That all depends. Some mortgage lenders will allow you to drop private mortgage insurance as soon as you have 20% equity in your home (i.e. you've paid off 20% of the loan). Others, however, require that you hold the private mortgage insurance for a specific number of years. Check with your mortgage company to find out if you are still required to carry private mortgage insurance, and if not, how you should go about dropping it. If you stay current on your payments, PMI should automatically drop off after your loan reaches 78% of the original property value. The exceptions to this rule begin to apply when you are not current on your loan payments and/or you are in a higher risk loan (ARM, Interest only, etc.).
**If you believe your property value has risen high enough so that your loan balance is 80% or below the value of the property, you can order an appraisal to prove this assessment and request the lender to drop your PMI.**
What's the Catch?
Most people don't even realize that they can cancel their private mortgage insurance at a certain time. When you close on a house, you are inundated with paperwork, and you might not read everything as closely as you should. The Private Mortgage Insurance Act (which went into effect in 1999) says that home owners have the right to cancel their insurance once they've met the requirements set forth by the mortgage lender. Be proactive and watch the equity in your house after you purchase it, and make sure that you've read all the paperwork carefully. There is no reason to pay an extra bill every month if you've met the necessary requirements.