Private Mortgage Insurance or PMI as it is known is a form of insurance that new homeowners are required to purchase. This is especially true if their down payment is 20% or less of the estimated price or sale price of the property. The primary reason for private mortgage insurance is to protect lenders in the event the new homeowner defaults on their home loan.
Although private mortgage insurance has a bad reputation for only protecting lenders, it's actually a good thing. The reason for this is that it has enabled millions of people to be able to purchase homes with smaller down payments. Previously, these people would not have been able to afford a house if the down payment had remained the same. Another important reason is that private mortgage insurance can help you get home loans.
Cost of private mortgage insurance
The cost actually varies depending on the mortgage loan and the monthly down payment. Usually it's half a percent. To calculate your private mortgage insurance, you can use this estimate formula:
Annual Private Mortgage Insurance = 100 - (percentage of down payment paid) * (house selling price) * 0.05
Let's take an example. Suppose you brought in a $500,000 house. You pay a deposit of 20%. So using the formula as above:
Annual Private Mortgage Insurance = (100 - 20) * $500,000 * 0.005 = $2,000
Your monthly mortgage insurance will be around $167.
An important point to note is that you should always track your payments and let your lender know when you've reached 80% of your home's equity. Even though the Homeowner Protection Act requires lenders to tell you how long it will take you to pay, it's always best to track it yourself.
In some cases, lenders require homeowners to maintain their private mortgage insurance for the life of the loan. This generally applies to high risk borrowers. Therefore, your payment history and credit rating, such as your FICO score, also play an important role.
Some people hate paying for private mortgage insurance for years. There are a few ways around this.
One way is to pay more interest on your home loan. Some lenders will waive the requirement for private mortgage insurance if you agree to pay a higher interest rate. Since mortgage interest is tax deductible, it may be a good idea to go ahead.
Another way to avoid paying for private mortgage insurance is to prove to the lender that your home has increased in value. If the value of your home has increased significantly, your home already has the 20% or more equity you need to void mortgage insurance. However, it takes time for the lender to verify your application, sometimes up to a year.
