Understanding Private Mortgage Insurance
What is Private Mortgage Insurance?
Private Mortgage Insurance is commonly called PMI. It means the insurance you pay to private mortgage company if your down payment is less than 20 per cent of the value of the property you want to buy. This is usually paid along with your monthly mortgage payment and property tax. You should not confuse Private Mortgage Insurance with the mortgage insurance premium that you pay when you borrow FHA loans. FHA loans are backed by the government. Therefore, the mortgage insurance premium is paid to the government. On the other hand, Private Mortgage Insurance is paid to private insurance company if you borrow conventional mortgage and you are unable to make at least 20 per cent down payment.
Is Private Mortgage Insurance Compulsory?
Private Mortgage Insurance is actually avoidable. It only becomes necessary when you fail to pay up to 20 per cent of the value of your home as down payment at the point of borrowing a private mortgage loan. If you can pay at least 20 per cent of the value of the property, then, you will not be required to pay Private Mortgage Insurance. Another way of avoiding PMI is to take another separate loan to pay for the shortfall on your down payment. Different terms and conditions will apply to the second loan. You may need to compare the interest you will have to pay on the second loan with the PMI you are trying to avoid so as to ensure that the second loan is justifiable.
Read Also: Understanding Down Payment on Mortgage Loan
Why Private Mortgage Insurance?
If you are unable to make 20 per cent down payment on your mortgage, lenders will see you as very risky. That is, the risk that you may default on your mortgage is high. As you know, if you default on mortgage, it can lead to foreclosure and the lender may not be able to recover his money. But with Private Mortgage Insurance, there is an assurance that the insurance company will compensate the lender.
How Long Do You Need to Pay Private Mortgage Insurance?
You may want to know whether you will be able to dump the PMI or it is something you need to continue to pay until you are able to pay off your mortgage. PMI is actually an additional cost and every homebuyer likes to eliminate it as soon as possible. PMI is not what you must continue paying but you will need to meet certain criteria before you can dump it. Firstly, you should understand what led to the payment of Private Mortgage Insurance. It is because your down payment was less than 20 per cent of the value of your home. So, if you want to dump the payment of PMI, you must ensure that you have paid your mortgage loan to the point that the loan to value of the property is equal to 80 per cent. That is, you must have built up to 20 per cent equity on your home. At this point, you can apply to your lender to remove the Private Mortgage Insurance. It is not automatic that your PMI will be cancelled when your loan to value is equal to 80 per cent. Some lender may require that you get a fresh appraisal of the home. While your application is still being processed, you will still need to continue paying the Private Mortgage Insurance. But by the time your mortgage balance has reduced to 78 per cent of your home’s purchase price, the lender is required by the Federal Homeowners Protection Act to cancel the Private Mortgage Insurance automatically. However, the must be able to demonstrate that the home is free from liens. Also, you must have a good credit history of prompt payment of your monthly mortgage.
Read Also: What to do Before Applying for a Mortgage Loan
Another method you can adopt to cancel the PMI is through refinancing. Refinancing may be a smart way of cancelling the Private Mortgage Insurance if the mortgage interest rate has gone down and the value of your home has gone up. Refinancing may help you get another loan at a cheaper interest rate. This will further save you some costs on interest payment. Before you can use this option, you need to be sure that there is no restriction on your mortgage. Some lenders will specify in the loan agreement that you will need to wait for certain specific number of years before you can refinance your mortgage.