The Ins and Outs of Today's Private Mortgage Insurance

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Published: 07th November 2012
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Anyone who has ever tried to purchase a home -- but didn't have enough cash on hand to put down a large down payment -- has probably heard of private mortgage insurance, or PMI.

While it may sound complicated, it's not. Simply put, PMI is intended to protect a lender from borrowers who may default on a loan -- while also making home ownership available to a larger portion of the population. In today's real estate market, most lenders will require you to pay PMI every month if you can't put down at least 20% on your new home.

When you're paying PMI, you are making monthly premium payments on an insurance policy that would partially reimburse the lender if you default on your loan. It's called "Private Mortgage Insurance" because these policies are only offered to private mortgage lending companies,.

Even though PMI cuts down on the bank's risk, you'll still have to impress your lender in the very beginning. You'll still need a suitable credit score, good history of employment, and all of the other things lenders look at when you apply for a loan.

Even though it's another monthly charge, PMI can help you and the bank.

It helps them because they'll still get the money owed to them on your loan, even if you default.

PMI benefits you because it can significantly decrease the down payment you have to make. In fact, a lender may approve your loan request with as little as 5% down payment.

Even though it will cost you $50 - $200 each month (depending on the value of your home), PMI allows you to proceed with home ownership today -- instead of having to wait several years while you save up the funds to pay a larger down payment.

So, is PMI required?

Yes. In fact, the banks have a law on their side that says anyone who cannot pay at least a 20% down payment for a new mortgage loan, can be required by a lender to purchase PMI.

But that same law -- the Homeowners Protection Act of 1998 -- also states that once a homeowner has exceeded 20% equity in the home's original value (meaning you've paid off 20% of your loan), the borrower can request to their lender that they be allowed to drop their PMI coverage. Once you reach 22% equity in a home, the PMI is automatically cancelled.

Of course, like any law, there are stipulations that you must follow.

For example, anyone who has 22% equity in their home -- but is behind on their payments -- is not covered by the automatic termination clause.

Can you avoid paying PMI altogether?

If you don't have the 20% down payment, ask your lender if there is anything you can to avoid paying PMI. Some lenders will allow you to take out a second mortgage on the home and use that as a down payment on the initial loan.

These are called "piggyback mortgages", but ever since the economy collapsed in 2008, fewer lenders have agreed to this type of deal.

What if you're already paying PMI? Is there anything you can do to get rid of it?

If you still haven't reach 20% equity yet, consider a refinance. You may be able to get a loan that offers the same term as your current loan -- but with a cheaper rate and no PMI.

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