What is private mortgage insurance?

Private mortgage insurance (PMI) is a way for buyers to get around the normal 20 percent down payment and still buy a home. It especially helps first-time homebuyers who don’t have proceeds from their previous home’s sale to help finance the new purchase.

Essentially it works like this: In exchange for being able make a down payment as low as 3 percent (depending on the lender and your situation), you agree to pay private mortgage insurance until you have paid the equivalent of 20 percent of your home’s purchase price. This is because mortgage lenders feel more secure that they could recoup their losses if you default on your loan. Although you are paying the premiums, it’s the mortgage lender -- not you -- who is protected by private mortgage insurance.

Since it can take years to save 20 percent of the purchase price at today’s home values, PMI lets you buy a home sooner. According to the National Association of REALTORS®, during the second quarter of 2006, the median home price of existing single-family homes in metropolitan areas was $227,500. Without private mortgage insurance, that would mean that you would need $45,500 in cash in order to get a mortgage loan.

Your private mortgage insurance premiums are likely to be higher if you make a three to five percent down payment, and they will probably be lower if your down payment is 10 percent or more. You might also have higher payments if you have an adjustable rate mortgage rather than a fixed-rate mortgage.

The premiums for private mortgage insurance are usually included in your monthly mortgage payments and are held in escrow until the payments are due to the mortgage insurance company. Typical annual PMI bills range from $250 to $1,200, according to the Federal Reserve.

You don’t have to pay for private mortgage insurance forever -- just until you have paid down 20 percent of the original value of your home. That can take a while because most of your mortgage payment goes to interest, not principal, in the early years of your loan. But if the value of your home has grown, either because of market conditions or improvements to the home, you can ask to have your private mortgage insurance canceled earlier.

In addition, federal law requires automatic cancellation of private mortgage insurance once you have achieved 22 percent equity in your home -- in other words, when you have paid 22 percent of the value of the home at the time of the loan. The law applies to most home mortgages signed on or after July 29, 1999.

There are exceptions to the automatic cancellation of private mortgage insurance, including high-risk or delinquent loans. But the law does protect most homeowners from unknowingly having to pay hundreds or even thousands of extra dollars for private mortgage insurance.

Note: For home loans originated in 2007, PMI may be tax deductible. Read more here: http://www.lendingtree.com/smartborrower/Down-payments/PMI-may-be-tax-deductible.aspx.


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