A commonly misunderstood part of a mortgage is PMI or Private Mortgage Insurance. In this article we will break down what PMI is, but first let me tell you what it is not.
What PMI is NOT.
Some people, often times first time home buyers, believe that Private Mortgage Insurance is a policy where if the borrower died the mortgage insurance would pay off the existing balance. This is not true, and in fact completely opposite of what PMI really is. PMI is built to protect the lender not you the borrower.
Others mistake PMI for Home Owners insurance, and believe it will protect them against damage or theft of their house. This is not the case as Homeowners Insurance is completely separate requirement, can never be removed, and is in place for the benefit of you.
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What PMI is.
Private Mortgage Insurance is a requirement for most, if not all, loans where the borrower has a mortgage more than 80% the value of the home. If you are purchasing a home and put less than a 20% down payment PMI will be required. Likewise if you are refinancing your home and the new loan amount exceeds 80% the appraised value PMI will be required.
PMI protects the lender on “risky” loans in case you as the borrower default.
So what is in it for me?
Good question. The answer… not much other than the ability to borrow over 80% or have less than a 20% down payment. Many people do not have enough money saved to put 20% down on a home; therefore PMI may be your only option.
How long will PMI last?
PMI is not good for the life of your loan. Two factors that naturally occur help reduce the time you are required to pay mortgage insurance. These factors are making your monthly payments and appreciation of your home. You can request your PMI be canceled when your mortgage equals 80% or less of the original purchase price or appraised value of your home at the time the loan was obtained, whichever value is less.
Good payment history for the previous 12 months is often required to drop PMI at 80% LTV (loan to value). Once your LTV equals 78% your lender is required by law to automatically remove the PMI. If you are delinquent during this time PMI will not be removed until your loan is current.
Finally, if neither option above is reached by the time the loan reaches the midpoint of its term PMI will be automatically canceled. For example if you have a 30 year loan with 360 payments once the 180th payment is made PMI must be canceled, provided you are current on your payments.
Can I avoid PMI without a 20% down payment?
Some lenders offer 2nd mortgage plans to avoid PMI. Commonly known as an 80-10-10 loan, in this scenario you borrow a first loan of 80% (no PMI because it is 80%), second loan of 10% and a 10% down payment. Although you avoid private mortgage insurance you have the risk of a high interest rate 2nd mortgage. 2nd Mortgages are often times adjustable rate mortgages, or even have a balloon payment at some point in the loan.
Ideally you would like to have 20% down payment so you can avoid PMI altogether. If you do not have that large of a down payment you will be required to carry PMI for a portion of your loan. Be sure to keep a close eye on the value of your home and the amount you have paid your mortgage down so you can cancel the mortgage insurance at any time.