How private mortgage insurance works and what you can do to avoid it
By Erik J. Martin
CTW Features
If you want to be a homeowner, you’ll need a mortgage, you’ll need insurance, and you may even need mortgage insurance – often called PMI, or “private mortgage insurance.” If you need it, you’ll be responsible for paying for it, despite the fact that this type of insurance isn’t in place to protect you; it exists to safeguard your lender.
PMI coverage is typically required on a mortgage loan when your down payment is less than 20 percent. It serves as a safety measure for the bank/lender in the event you can’t pay for your mortgage, says Mike Mirshahzadeh, chief revenue officer for The Money Source, Melville, New York.
“Lenders require PMI on loans because it reduces the risk of loss in the event the loan ends up defaulting,” Mirshahzadeh says. “In the event of a foreclosure on your home, the mortgage insurance company would pay the lender part of their losses.”
For example, say you take out a loan for $180,000 on a $200,000 home – which equates to a 10 percent down payment, triggering the need for PMI. If you default on the loan a few years later and the home sells for $165,000, the PMI insurer will need to reimburse the lender the $15,000 difference between the loan amount and the sales price.
With a conventional loan, your lender will set up PMI with a private company, which you will pay monthly premiums to, with little to no initial payment needed at closing; with an FHA loan, you’ll pay mortgage insurance premiums directly to the Federal Housing Administration both as an upfront cost at closing and as a monthly premium included in your monthly mortgage payment (for more details, visit tinyurl.com/PMI411).
PMI fees/premiums are usually calculated based on the amount of coverage the lender requires, which is determined by risk factors associated with the mortgage – including your credit history, down payment amount, mortgage loan type (fixed-rate or adjustable-rate), and type of loan documentation.
David Hosterman, branch manager with Castle & Cooke Mortgage LLC in Greenwood Village, Colorado, says PMI costs on conventional loans currently range from 0.21 percent to 1.48 percent of the loan amount.
“You may be able to opt for a single-premium mortgage insurance to avoid having monthly PMI. This is typically an upfront charge by the borrower which allows you to buy out of the mortgage insurance for the life of the loan,” Hosterman says.
To cancel PMI, you have to earn a minimum of 20 percent equity in your home. You can request that your lender discontinue PMI after you’ve decreased your mortgage balance to 80 percent of your property’s original appraised value. You may be able to eliminate PMI sooner if you refinance, prepay your mortgage (make accelerated payments that pay down your balance sooner) or request a new appraisal of your home.
To avoid PMI from the start, aim to save up for the minimum 20 percent down payment. One strategy is to ask a friend or relative for financial help in the form of a gift (not a private loan) that the lender will need to verify.
“Also, consider applying for a piggyback loan, also called an 80/10 loan, in which you get a first and second mortgage at the same time. The first loan covers 80 percent, and the second loan covers 10 percent, thereby covering 90 percent of your purchase price and allowing you to put down 10 percent,” says Robert Flower, vice president of sales for Associated Mortgage Bankers, Inc. in Floral Park, New York.
Alternatively, consider other low-down payment loans that don’t require mortgage insurance.
“VA loans require zero down payment and no mortgage insurance, although the approval process can take longer,” says Mark Ferguson, Denver-based Realtor and creator of Invest Four More. “Additionally, some local down payment assistance programs, which vary by state, have no mortgage insurance requirements. Check with a knowledgeable lender in your area to see if you qualify.”
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