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 always tax deductible.1 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 get rid of PMI insurance altogether:
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.
It’s the same principle 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.
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.
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.
1 Recent legislation has passed making PMI insurance tax deductible, much like mortgage interest and property taxes. There are some restrictions, such as the property must be your primary residence, your adjusted gross income must be $100k or less for full deduction (partial deductions up to $109K), and the origination of your mortgage must have occurred on or after January 1, 2007. Lawmakers have extended this private mor