Private Mortgage Insurance
A frequently misunderstood aspects of mortgaging a home, especially for first-time buyers, is Private Mortgage Insurance (PMI). The most common misconception is that PMI is a type of mortgage life insurance policy, whereby the mortgage would be paid off should the borrower die. It is not. PMI is insurance that most lenders require of borrowers who put less than 20% down toward the purchase of the property. It's purpose is to protect the lender against losses should the borrower default.
Almost all conventional mortgages with less than a 20% down payment require PMI. FHA mortgages, which are insured by the Federal Government, require a different type of insurance with different coverage. The cost of PMI will depend on the insurance carrier and the amount of the mortgage loan. Monthly payments for Private Mortgage Insurance generally amounts to $ 25 - $ 100 for median priced homes. |
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Many buyers ask if they are paying the premium, but the lender is the one being protected, what's in it for them? The benefit is that PMI allows the borrower to purchase a home with less than 20% down payment. Lenders have found that those who put down less than 20% are far more likely to default than those who put down more. The protection of PMI allows lenders to make more loans with down payments as low as 5% or 10%. This is especially important to first-time buyers, where cash for down payments and closing costs is often limited.
Unlike the mortgage insurance on FHA loans, which remains in place throughout the term of the loan, under certain circumstances PMI can be cancelled. The Homeowners Protection Act of 1998 simplified this cancellation process. Previously it was a very complex process to get the PMI cancelled. Today the procedure is much less complicated and time consuming. For qualifying loans originated after July 29, 1999, the home owner has the right to request cancellation when the mortgage balance falls below 80% of the original purchase price, or the appraised value, whichever is less. To request PMI cancellation, the loan must be current, have no delinquencies in the last 1-2 years, and may require an appraisal of the houses current value at the home owner's expense.
The Homeowners Protection Act also stipulates (in the case of most loans) that when the balance reaches 78%, cancellation is automatic. As before, the loan must be current.
Tips on PMI
- Your first goal should be a 20% down payment because this achieves a variety of goals. First, it eliminates the need for PMI entirely. Second, it lowers your monthly payment. Third, it allows you to buy more house because the money that would have gone toward PMI can now go toward a higher monthly mortgage payment.
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There are plans which allow you to avoid PMI altogether by getting an immediate 2nd mortgage when you purchase the home. For example, you would get a first mortgage for 80% of the purchase price (no PMI), a 2nd mortgage for 10% of the purchase price and put 10% down in cash (commonly known as an 80-10-10 mortgage, see Personal Mortgage Brokers for more information. The benefit here is obvious (you avoid PMI) but there are several potential down side issues:
- The 2nd mortgage will mot likely be at a rate higher than the 1st mortgage.
- The 2nd mortgage may be a variable rate loan, meaning that the monthly payment may increase over the term of the loan.
- The 2nd mortgage may have a balloon payment, meaning that the new balance will become due and payable long before the 1st mortgage is paid off.
PMI is NOT mortgage life insurance. Although PMI appears to benefit only the lender there is the advantage that the home buyer can purchase a home with a smaller down payment. Be certain to keep a close watch on the equity in your home so that you can cancel the PMI at the first possible opportunity.
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