What Is Private Mortgage Insurance – PMI?
You pay for private mortgage insurance but it doesn't insure you
There are several types of mortgage insurance. The one that everybody complains about is private mortgage insurance (PMI). Homeowners with private mortgage insurance have to pay a hefty premium and the insurance doesn't even cover them. Yes, private mortgage insurance offers zero protection for the borrower. Borrowers mistakenly think that private mortgage insurance makes them special, but there are no private services offered with this kind of insurance.
A lesser-known type of mortgage insurance is the type that pays off your mortgage if you die. In other words, you pay a small premium for a small chance of dying. You could probably get better protection through a life insurance policy. The type of mortgage insurance most people carry is the type that insures the lender in the event the borrower stops paying the mortgage. Nonsensical, but private mortgage insurance insures your lender.
Why You Have to Pay for Private Mortgage Insurance
Many borrowers take out private mortgage insurance because their lender requires it. That's because the borrower is putting down less than 20 percent of the sales price as a down payment. The less a borrower puts down, the higher the risk to the lender. Therefore the lender wants insurance against a default.
You don't choose the mortgage insurance company and you can't negotiate the premiums. It sounds unAmerican, but that's what happens when you get a mortgage that exceeds 80 percent loan-to-value (LTV).
What Less Than 20 Percent Looks Like
For example, if you put down 5 percent on a $200,000 home and stopped making your mortgage payments, mortgage insurance would pay your lender $30,000, which is the 15 percent that you did not put down to protect the lender to an 80 percent LTV. This would happen after foreclosure.
The Federal Housing Administration (FHA) charges for mortgage insurance as well. Not only do you pay an upfront premium for mortgage insurance, but you pay a monthly premium, along with your principal, interest, insurance for property coverage, and taxes.
When You Can Cancel Private Mortgage Insurance
Once your equity rises above 20 percent, either through paying down your mortgage or appreciation, you might be eligible to stop paying PMI. The first step is to call your lender and ask how you can cancel your private mortgage insurance.
The lender will want proof that your equity position is secure and exceeds 20 percent. It will get that proof by requiring you to pay for an independent appraisal. You don't get a voice in choosing the appraiser or the amount that the appraisal will cost you, but generally, appraisals cost between $350 and $500.
FHA rules are different. If you have an FHA loan, you will need to pay down your mortgage to 78 percent of your original sales price. Even if appreciation has pushed your equity up, it won't matter. You will need to reduce your original principal balance.
How to Avoid Paying for Private Mortgage Insurance
There are many ways to avoid paying for private mortgage insurance. You may not qualify for these, or may not want to employ them.
- If you are a veteran, you can take out a VA loan, which has no private mortgage insurance.
- You can put down 20 percent or more if you want to tap the Bank of Mom and Dad.
- You can pay a higher interest rate. Sometimes the difference in your monthly payment spread out over your planned term of occupancy is much less than paying for mortgage insurance.
- You can take out a combination loan of 80 / 10 / 10. This consists of a 10 percent down payment, an 80 percent first mortgage and 10 percent second mortgage.
- You can look into a HomePath mortgage offered by Fannie Mae on select Fannie Mae bank-owned homes.
- If you're a teacher or doctor your bank may give you a special loan. Sometimes, loans to teachers and doctors don't require private mortgage insurance.