What Is Private Mortgage Insurance And When Do You Need It?

Learn what private mortgage insurance is and whether you need it when getting a mortgage on your home.

Private Mortgage Insurance (PMI) also known as Mortgage Guarantee Insurance is an insurance policy that protects a financial institution. If a borrower defaults on a loan, the mortgagee is covered.

Lenders typically require PMI for borrowers who are purchasing a home with less than 20 percent down. A lender typically will finance 80 percent or less of a home's value. So, if a buyer has 3 percent to put down on a home, the lender would take out a PMI policy that would cover the other 17 percent should the buyer default.

Statistics have shown that the less equity a homeowner has, the more likely they are to default on the loan. The price of PMI is based on the purchase price of the home and can range anywhere from $30 a month to more than $100 a month.

In 1998, the Federal Homeowners Protection Act was passed. The law makes both consumers and lenders responsible for how long PMI coverage is required. Before the law went into effect, consumers were required to track their loan balance and calculate when they had enough equity to end PMI. Many consumers were unaware that they could request cancellation of PMI and many continued to pay for it unnecessarily.

The law states that for mortgages written after July 29, 1999, PMI must be automatically stopped when a homeowner reaches 22 percent equity in their home, based on the purchase price. However, there are certain exceptions, they include, "high-risk" loans and those who have not been current on their payments within the year.

Under the Federal Homeowners Protection Act, homeowners can cancel PMI themselves when they reach 20 percent equity in their home. Similarly, any homeowners with mortgages in effect before July 29, 1999 who have 20 percent equity in their home can cancel their PMI. The law does not cover VA or FHA government-guaranteed loans.

Since most loans are structured in a way that the first few years of payments are finance charges, it could take more than 10 years to pay a loan down to 80 percent. However, if the property value has increased, or home improvements have been made that increase the property value, it may be possible to cancel PMI coverage. While the law does not require a lender to consider the current property value in relation to PMI, it does not hurt to contact them to see if they would be willing to.

PMI can help homeowners that don't have a large down payment purchase a home. With the protection of PMI, lenders are able to approve loans to buyers with as little as 3 percent down. Typically, the non-tax deductible PMI payment is collected as part of the mortgage payment and is listed separately on the mortgage papers.

When getting a mortgage, it is important to shop around. Some loans can be structured in a way that there are two separate loans for the home, one for 20 percent of the purchase price and one for 80 percent, thus avoiding PMI altogether.

Either way, pay close attention to the loan documents. Know whether you are being charged for PMI and when the payments should cease. It is also a good idea to keep track of your home value and the equity you have, it may save you thousands of dollars in unnecessary PMI payments.

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