What is PMI? PMI, or
private mortgage insurance, is an insurance that home
buyers are required to purchase if their down payment
is low. Private mortgage insurance is usually required
of home buyers whose down payment is 20 percent or less
of the property’s sale price or appraised value.
This insurance was created by private mortgage insurers,
and was created to provide protection for the lender
in the case that the home buyer should default on the
loan.
Private mortgage insurance has helped create millions
of new homeowners by allowing people to buy homes with
much smaller down payments than had previously been
accepted. As home prices continue to soar, the ability
to purchase a home with a small down payment has become
even more important. Private mortgage insurance allows
potential homeowners to buy a home sooner, with even
just a 5 percent down payment. Also, private mortgage
insurance can help you qualify for a greater number
of home loans.
The cost of private mortgage insurance varies according
to the down payment and mortgage loan, but it typically
equals approximately one half of one percent of the
total amount of the loan. But how exactly is private
mortgage insurance calculated? Let’s assume you
bought a house for $100,000, for which you put set down
a 10 percent down payment. Your lender will multiply
the remaining 90 percent by .005 percent. The result,
$450, is your annual private mortgage insurance, which
is divided into monthly payments.
After a few years of paying down your mortgage loan,
you should be able to stop paying private mortgage insurance.
You should keep track of your payments and contact your
lender when you reach 80 percent equity so that your
private mortgage insurance can be cancelled. In 1999,
a new law, the Homeowner’s Protection Act, was
passed that requires lenders to notify you, the buyer,
how many months and years it will take for you to pay
the 20 percent of your principal. However, it is still
a good idea to keep track of it on your own.
This same law also allows lenders to make certain buyers
continue their private mortgage insurance, all the way
to 50 percent equity. This requirement applies to buyers
classified as high risk borrowers. Some Federal Housing
Administration loans may even require that home buyers
acquire Private mortgage insurance through the lifetime
of the loan.
If the idea of paying private mortgage insurance for
years sounds unappealing, you’re not alone. Over
the years, new ways of avoiding payment of the private
mortgage insurance—even when you don’t have
the 20 percent down payment available—have emerged.
One strategy commonly employed to avoid paying private
mortgage insurance is to pay more interest on your mortgage
loan. Some lenders will waive the private mortgage insurance
requirement if the home buyer agrees to pay a higher
interest rate on their mortgage loan. One advantage
to this strategy is that mortgage interest becomes tax
deductible.
Another way to avoid paying private mortgage insurance
is by using the ’80-10-10’ loan strategy.
This strategy involves taking on two loans and putting
down a 10 percent down payment to purchase a home. One
loan finances 80 percent of the mortgage, while the
second loan finances the remaining 10 percent of the
sales price. The second mortgage—the one that
covers the 10 percent—has a higher interest rate.
But since the amount of the loan is low, the interest
charges are relatively easy to pay off. Under this plan,
the mortgage interest is also tax deductible.
You may also be able to cancel your private mortgage
insurance if you can prove that your home has increased
significantly in value. If the value of your home has
gone up, you may already have 20 percent (or more) of
the equity you need to cancel your private mortgage
insurance. You can submit evidence of this to your lender,
but the process is slow. Expect to wait up to two years
for the lender to make a decision.
You may be required to continue paying private mortgage
insurance, however, if you have a poor payment history,
or if your credit record reflects any liens placed against
your property. You should speak to your lender to see
how any changes in your credit record may affect your
use of private mortgage insurance.
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