What You Need to Know About Private Mortgage Insurance

Private mortgage insurance is just what the name implies: insurance that covers the lender in case the home buyer defaults. If you put less than 20 percent down on most mortgages, chances are your lender will require you to have private mortgage insurance, commonly known as PMI.

Unless you have a government-insured loan, such as an FHA or VA loan, you don’t have much choice in the matter. And the benefit of private mortgage insurance is it allows you to buy the home you want even if you don’t have a large down payment. The lender will obtain private mortgage insurance for you.

Paying private mortgage insurance

There are a couple of ways to handle your private mortgage insurance payment.

One popular payment method is to include private mortgage insurance as part of your monthly mortgage payment. PMI generally costs about one-half of 1 percent of the cost of your house, or $75 a month for an $180,000 mortgage.

Another way of paying for private mortgage insurance is to finance it when you get the mortgage. That would generally increase your interest rate, possibly by one-half of 1 percent. Mortgage interest is likely tax-deductible while private mortgage insurance may not be. (Consult a tax advisor about your situation.)

You can cancel PMI

You don’t have to pay PMI forever. You can ask to have it canceled after you have built up 20 percent equity in your home. This means if your home is worth $200,000, you have at least $40,000 in equity in your home. And you don’t have to pay down your mortgage to build equity, either. If you have made significant home improvements or your property has appreciated significantly in value, you may be able to cancel private mortgage insurance even earlier. The lender may require you to pay for an appraiser to establish your home’s value in today’s market.

If you signed your mortgage on or after July 29, 1999, a federal law requires lenders to automatically – with a few exceptions – cancel your private mortgage insurance once you have paid 22 percent of the principal based on the original loan amount.

Lenders do have some leeway to refuse to cancel your PMI if you are not current on your payments, if there are liens against the property or if you have an exceptional amount of debt based on your income.

Some people avoid private mortgage insurance by getting a small home equity loan to “piggyback” on the mortgage. The piggyback loan pays for the rest of the down payment so the buyer is able to put 20 percent down. These loans carry a higher interest rate than the mortgage, but the interest may be tax-deductible. A financial advisor can help you figure out how to determine if private mortgage insurance is the best way for you to buy a home.