What is Private Mortgage Insurance (PMI)?
PMI or Private Mortgage Insurance is normally required when you buy a house with less than 20% down. Mortgage insurance is a type of guarantee that helps protect lenders against the costs of foreclosure. This insurance protection is provided by private mortgage-insurance companies. It enables lenders to accept lower down payments than they would normally accept. In effect, mortgage insurance provides what the equity of a higher down payment would provide to cover a lender's losses in the unfortunate event of foreclosure. Therefore, without mortgage insurance, you might not be able to buy a home without a 20% down payment. Why do homeowners get saddled with private mortgage insurance anyway? This is insurance for the lender that is now necessary because so many people defaulted on their mortgage loans.
In reality, PMI saves everyone money because without the security offered by this insurance, lenders would be far less likely to lend so much money at such low interest rates. After all, no lender likes high risk borrowers and folks who don't have twenty percent to put down seem risky. Plus, PMI is not forever. Once you have your twenty percent in your home you can refinance and PMI will go away, but your low interest rate won't. In most cases, PMI can be dropped after the loan to value ration drops below 80 percent. 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. For other loans, find out from your lender what procedure to follow to have PMI removed when your equity reaches 20 percent.
Why Do We Need Private Mortgage Insurance (PMI)?
PMI is insurance that lenders require for borrowers seeking loans of more than 80% of a home's purchase price. PMI protects the lender if default should occur, and enables home buyers with down payments of less than 20% to purchase homes. Generally, if you put down 20% or more, you won't need PMI.
Here's how PMI works:
- You have a 5% downpayment.
- The lender wants to finance 80% or less of the home's value, since studies show that buyers who put less down are more likely to default.
- The lender secures a private mortgage insurance policy for you and closes on the loan. You pay for the PMI policy at closing or (most often) you pay a fee with each monthly loan payment.
- If you default, the lender receives the 15% you did not pay at closing.