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8. Mortgage Basics - About Private Mortgage Insurance

About Private Mortgage Insurance (PMI):

Another good reason to put as much down payment as possible when purchasing a home is that you may be able to avoid having to purchase private mortgage insurance (PMI), also known as "mortgage default insurance", which can add hundreds of dollars annually to your loan cost, and ironically enough, may make it more difficult to qualify for a mortgage. You will likely have to pay PMI if your down payment is less than 20 percent of your home's purchase price. The reasoning behind this is that the smaller your initial down payment, the less you have invested in your property, and the more likely you are to default on your loan. PMI protects the lender in case this happens. PMI charges vary depending on the size of the down payment, but typically amount to one-half of one percent of the loan. Even if you can't afford a down payment of 20 percent, don't despair, because after the equity in your property increases to 20 percent, you no longer need this insurance, but this can take years on a long-term mortgage. Lenders are now required by law to inform you when this threshold is reached.


Also, be aware that if you have a spotty credit history, or fail to provide adequate proof of income or other information during the approval process, or are considered a high-risk borrower, you may be required to pay PMI until you reach 50 percent equity. And some loans, like those obtained through FHA, may require that you pay PMI throughout the life of your loan.

Example:
Let's say you want to purchase a house that costs $200,000, but you can only afford to put down 10%, or $20,000. The lender will multiply the remaining 90%, or $180,000, by 0.005 percent, which results in an annual PMI of $900. This amount is then divided into monthly installments of $75.

How to Avoid PMI:
As the example above demonstrates, avoiding the PMI can save you lots of money. But if saving up enough money to make a 20 percent down payment is difficult, there are ways that you can avoid this added cost:
Pay more interest: Some lenders may be willing to waive the PMI if you agree to pay a higher interest on your loan. Depending on the amount of the down payment, the rate increase can vary from .75 to 1 percent of the loan. One advantage with this option is that the interest is tax deductible.
80-10-10 Financing: With this program, you are essentially taking out two loans - an 80 percent loan with your primary lender, and an additional 10 percent loan through a secondary mortgage - and making a cash down payment equal to 10 percent of your home's purchase price. The second mortgage will be at a higher interest rate, and can be obtained from a variety of sources, including the seller of the home or even the same lender from whom you obtained the 80 percent loan. Best of all, the interest on both loans are tax deductible.

Example:
Say you want to purchase a $200,000 home, and you put down a 10 percent ($20,000) down payment. To cover the rest of the cost, you obtain a $180,000 (90 percent of purchase price), 30 year, fixed rate mortgage with a 6.5 percent interest rate. Your monthly loan payment will be $1,264.14, and PMI will cost an additional, non-tax deductible $75 per month. Your total monthly payment will be $1,339.14

If you do 80-10-10 financing on that same $200,000 house, you put a 10 percent down payment ($20,000). The first mortgage, equal to 80 percent of the sale price, is $160,000 with an interest rate of 6.5 percent, which comes to $1,011.31 per month. The second mortgage for $20,000 has a 10 percent interest rate, and comes to $175.51 per month. The total payment for these two loans is $1186.82, saving you $152.32 a month in PMI costs.

Removing PMI:
If your initial down payment was less than 20 percent, chances are you were required to pay private mortgage insurance (PMI) when you obtained your loan. PMI protects the lender in case you default on your loan. PMI charges vary depending on the size of the down payment, but typically amount to one-half of one percent of the loan. Fortunately, once you reach 20 percent equity, PMI is no longer charged. PMI may also be removed if there has been a recent appreciation in real estate prices in your neighborhood.

Before signing your mortgage note, ask your lender written disclosure detailing when PMI premiums can be removed from the mortgage payments. Keep track of your payments and your mortgage balance, and try not to be delinquent, as some servicers may require 12 to 24 months of consecutive monthly payments, and contact your mortgage servicer once you reach 20 percent equity if they have not contacted you. If you can afford it, try to make extra payment toward your principal each month. You may also be charged for a new appraisal if your lender feels it is necessary.

Other ways to remove PMI:
As stated before, PMI may also be removed if the market value of your home has increased. This can happen if there has been an appreciation in the real estate value of homes in your neighborhood. If you are unsure, you can contact a real estate agent familiar with your area and have them provide an analysis of the value of your home. You can also take steps towards increasing the value of your home by renovating it yourself.

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