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Private Mortgage Insurance

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Down payments for a new home ideally are around 20% of the total cost of the home. For many, that is an overwhelming amount of money to have to pay at once. You might be thinking that, since you can’t shell out that kind of cash, you’re never going to be able to get a house. Private mortgage insurance (PMI) can be a means for people in this position to get a home.

How Does PMI Work?

It’s important for you, as the homebuyer, to know that PMI isn’t in any way designed to protect you. It protects the lender. Putting down a lower down payment (as little as 0-5% with a PMI) is risky for the lender, so they secure a PMI policy for you, for which you pay a fee along with your monthly loan payment. Say you make a 5% down payment at closing. If you were to default on the loan, the lender would receive (from the PMI) the difference between an ideal down payment of 20% and what you actually put down, in this case, 15%.

How Much Does PMI Cost?

PMI payments can be pretty expensive, so if there’s any way you can avoid getting it, you should. That being said, just like with any insurance, premiums for PMI policies vary but usually fall between 0.5% and 1% of the loan. For a $150,000 loan with a $7,500 down payment, you’d probably pay between $80 and $120 per month for your PMI.

Canceling PMI

The good news for you if you have to get PMI is that you don’t have to retain it all the way through the term of the loan. Once the equity in your home is under the 80% loan-to-value ratio (LTV) (meaning you owe less than 80% of the home’s value), you can cancel your PMI. Here are some ways you might reach that point:
  • Increase in home value: If you’re home value goes up, and you reach the required LTV of 80%, it becomes possible for you to cancel your PMI. One great way to raise your home’s value is to remodel.

  • Pay down your mortgage: You can pay your mortgage down until it’s under the 80% LTV and then cancel your PMI.

  • Automatic termination: You can arrange for your PMI to be cancelled automatically once you’ve reached a 20% equity in your mortgage. In addition, the Homeowner’s Protection Act of 1998 requires lenders to terminate your PMI when you reach a 78% loan-to-value ratio.
Make sure you keep an eye on these things, so you can be sure your PMI gets cancelled when it’s possible. You don’t want to be making payments for insurance that you don’t need.

Other Information About PMI

  • Perhaps one of the most important things about PMI is that premiums are tax-deductible for buyers whose annual household income is $100,000 or less. This means that, while your up-front cost may be high, you’ll get it back in your tax return.

  • Your lender is required by law to remind you annually of your right to request cancellation of your PMI.

  • PMI premiums are fixed. You won’t have to worry about your premiums going up. Of course, they won’t go down either.
Private mortgage insurance isn’t ideal, but it can be a huge benefit to those who need it. It makes it possible for low-income families to get a home. The inconvenience of paying a monthly fee pales in comparison to being able to put a roof over the heads of you and your family.

Patrick Hanan  Posted by Patrick Hanan on June 15, 2010

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