What is Private Mortgage Insurance?

By FrontDoor.com | Published: 11/01/2007

Every lender wants to protect itself in case a borrower defaults on a loan. That's what private mortgage insurance does. Homebuyers who don't fork over a cash down payment of at least 20 percent of the purchase price may be required to buy private mortgage insurance, or PMI, for the lender. That's right. You buy insurance to protect them from loss.

If you need PMI, your lending officer will generally refer you to a mortgage insurance firm he or she works with. PMI costs vary, but premiums run about 0.50 percent of the loan amount for the first year of the loan, which you usually pay at the close of escrow. Most premiums are lower for subsequent years.

Once you have at least 20 percent equity in the home, PMI can be dropped. The Homeowners Protection Act requires PMI to be dropped when the loan-to-value ratio reaches 78 percent of the home's original value and the loan closed after July 29, 1999.

PMI is so unpopular with buyers that lenders look for ways around it. Ask your lender about your options. In some cases, you can take a slightly higher interest rate or additional points at closing in lieu of paying PMI. Many borrowers usually opt for piggyback mortgages in which the mortgage loan is divided into two or three chunks at different interest rates. This is often set up as an 80/20 or 80/10/10. The smaller mortgages will have higher interest rates than the main one.

In 2007, for the first time, private mortgage insurance became a tax-deductible expense. This law is not permanent and has to be renewed each year, however, so your safest bet is to get a no-PMI loan or a piggyback mortgage.

There are times when it's wise to make a down payment of smaller than 20 percent and pay for PMI - like if you intend to remodel a house soon after you buy it. If your improvements increase the value of the home, you'll have more equity (cash) in the house. Read about ways to increase the value of your home. The increased equity could bring you to the magic 20 percent threshold at which the PMI goes away.

It works like this. You buy a cute little Craftsman bungalow for $300,000 with 10 percent (or $30,000) down. You remodel it so that a year later it's worth $330,000, which is $30,000 more than your mortgage (equity). With that additional equity, you now hold 20 percent of the home's value and can have the PMI removed.

GO TO: Part 1: Evaluate Your Life and Finances

GO TO: Part 2: Shop for a Loan

GO TO: Part 3: Find a House

GO TO: Part 4: Close the Deal

GO TO: First-Time Homebuyer's Guide

More on FrontDoor:

• Search Homes for Sale
• House Hunters Homebuying Guide
• Home Finance Guide
• Foreclosure Guide
• Moving Guide
• Tools and Calculators

Comments