Private Mortgage Insurance
What Is Private Mortgage Insurance?
If you purchase a home and make a down payment of less than 20% of the purchase price, you may be required to purchase private mortgage insurance (PMI). In essence, PMI is a fee which provides compensation to the lender in the event the borrower defaults on the mortgage.
Example: Jonas has found his dream house. The cost of the house is $100,000. Jonas plans to make a down payment of $10,000. The down payment represents 10% of the cost of the house. It may be necessary for Jonas to purchase PMI, but other options may be available as well.
While PMI is beneficial in that it allows many borrowers to obtain mortgage loans, it can add a significant amount to your monthly mortgage payment -- it could be as little as $25, but it could result in a monthly charge well in excess of $100.
Is There Any Way to Avoid PMI?
It is possible to avoid PMI entirely by making an initial down payment of 20% or more when you purchase your home. Often, however, it is not possible for borrowers to make such a sizable down payment.
One way to avoid PMI is by structuring the home purchase as an "80-10-10" transaction. If a borrower can make a down payment of 10% of the purchase price, it may be possible for the borrower to obtain a loan for the additional 10%, as well as a loan for the remaining 80% . While the cost of the loan for the additional 10% may be somewhat higher than the cost of the loan for the 80%, it may be worthwhile in that the borrower will avoid the cost of PMI and may be entitled to some tax benefit for the interest attributable to the additional loan.
Example: In Jonas' case, he will make the down payment of 10% from his savings of $10,000. Jonas would then obtain a loan in the additional amount of $10,000, as well as a loan for the remaining $80,000. The total of Jonas' down payment, the additional loan, and the loan for the remainder, is the purchase price of $100,000. Jonas would not be required to obtain PMI.
Once I Have PMI, Can I Ever Cancel It?
The answer is "Yes." In thinking about PMI, it is very important to keep in mind that PMI relates to the percentage of the down payment in relation to the purchase price of the house, not to the value of the house. Usually, a borrower can cancel PMI once the borrower's equity in the house reaches 20%. If you believe, based on sales of comparable houses in your area, that the equity you have in your house is 20% or greater, you might consider contacting your loan servicer for information on the procedure to cancel PMI. Your loan servicer may require a professional appraiser of your house as part of the procedure, but the cost of the appraisal may be lower than the continued cost of PMI.
Example: After a series of unexpected events before the settlement on his house, Jonas was able to make a down payment of only 5% or $5,000. As a result, Jonas purchased PMI. The home Jonas purchased was a true "handyman's special." During the first year he owned the house, Jonas added a new kitchen, new bathrooms, and made extensive renovations to the rest of the house. After only one year, the house was reappraised at a value of $200,000. The amount of Jonas' equity is now in excess of 20%, and Jonas should contact his loan servicer for information on the procedure to cancel his PMI.
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