For many homebuyers, private mortgage insurance may not be the most celebrated form of insurance, but,
for some, it’s an absolute must. For those individuals who wouldn’t typically be able to afford a large 20
percent down payment, it’s a “foot in the door,” allowing for homeownership with as little as a 0-5 percent
down payment.
Private Mortgage Insurance (PMI) is insurance that protects your lender against non-payment should you
default on your loan. It’s important to understand that the primary and only real purpose for mortgage
insurance is to protect your lender—not you. As the buyer of this coverage, you’re paying the premiums, so
that your lender is protected. PMI is often required by lenders due to the higher level of default risk that’s
associated with low down payment loans. Consequently, it’s sole and only benefit to you is a lower down
payment mortgage.
How much does it cost?
The average costs of mortgage insurance premiums vary, but typically they fall between one-half and one
percent of the loan amount, depending on the size of the down payment and loan specifics. On a $200,000
loan with a $10,000 down payment, you might expect to pay somewhere around $85 a month, or about
$1000 a year, in addition to your mortgage payment. Unlike your mortgage interest, these premiums are not
tax deductible. Mortgage insurance is one of the few types of insurance products that doesn’t underwrite it’s
premiums based on individual default risk, rather the size of the borrower’s mortgage and the amount of
money put down determine the mortgage insurance quote. So, two individuals—regardless of credit—with
the same mortgage amount and down payment can expect to pay about the same PMI premium.
Private Mortgage Insurance and Mortgage Protection Insurance
Private mortgage insurance and mortgage protection insurance are often confused.
Though they sound similar, they’re two totally different types of insurance products.
Mortgage protection insurance is essentially a life insurance policy designed to pay
off your mortgage in the event of your death. Whereas, private mortgage insurance
protects your lender, allowing you to finance a home with a smaller down-payment.
These two products should never be construed as substitutes for each other.
Canceling or Terminating PMI
So, you don’t like the idea of making those extra mortgage insurance payments?
Here are a few ways to eliminate mortgage insurance altogether:
Appraisal
If the value of your home has risen in recent years you may be able to terminate
your mortgage insurance. Once the equity in your home falls below the 80
percent loan-to-value-ratio required by your lender, you can eliminate your
private mortgage insurance. You would, of course, have to present your lender
with a valid home appraisal before final termination. The costs associated with
getting an appraisal may or may not be worthwhile, depending on your unique
mortgage situation.
Remodel
It’s the same principal as above. By making home improvements, you’re
increasing the market value of your house, getting you that much closer to the
all-important 80 percent “LTV” level.
Pay down your mortgage
Paying down your mortgage may also be a viable option. Making even small
additional payments each month can make a big difference over time. Once
you get that loan-to-value-ratio below 80 percent, you’ll no longer be required to
make PMI payments.
Piggyback loan
Utilizing a piggyback loan such as a “80/20 loan” will allow you to avoid private mortgage
insurance. And by doing so, you typically avoid any “out of pocket” down payment, with the added
benefit of a tax deduction. By piggybacking a second mortgage onto your first mortgage, you’re
achieving the desired 80% “LTV” on the first mortgage, and avoiding the PMI. The downside with
these types of mortgage vehicles is that the second mortgage usually comes at a substantially higher
interest rate, making PMI savings negligible. However, by utilizing a 80/10/10 type loan with the last
10 percent going towards the down payment, you’ll often pay less than a straight loan with mortgage
insurance.
Automatic termination
Thanks to The Homeowner’s Protection Act (HPA) of 1998, you have the right to request private
mortgage insurance cancellation when you reach a 20 percent equity in your mortgage. What’s more,
lenders are required to automatically cancel PMI coverage when a 78 percent loan to value is reached.
Some exceptions to these provisions, such as liens on property or not keeping up with payments, may
require further PMI coverage.
Without a doubt, private mortgage insurance has proven invaluable for families trying to attain the American
dream of homeownership. It affords these individuals an opportunity that isn’t always easily achieved in this
otherwise inflated real estate market. Paying more or longer than needed isn’t prudent, however, and it’s
highly recommended that all steps are taken to avoid unnecessary payment. Knowing when to cancel can
save you thousands, so make sure to utilize all the resources available to you and cancel when you reach
the proper equity level, otherwise, it’s just money down the drain
