Understanding Financing Terms

Private Mortgage Insurance: 3 Things to Know

When you shop for a mortgage loan, your lender might offer you several options. Some of the loans you qualify for might require paying private mortgage insurance (PMI). This insurance is something that specific loan programs require if you do not have a large enough down payment. If you do not understand what this is, here are three things you should know.

The Purpose of PMI

The first thing to know is what PMI is and the purpose it serves. PMI is an insurance product that borrowers pay to their lenders each month, serving one purpose. The purpose is to protect the lender. If you borrow money to buy a house and default on the loan, your lender can foreclose on the house. If this happens, your lender might lose money on the deal. Lenders charge PMI to avoid losing money. This insurance protects the lenders by compensating them for money lost due to foreclosures.

The Cost of PMI

The next thing to understand is the costs of PMI. PMI often costs up to 1% of the total loan amount. If your lender charges 1% of the loan amount, your annual PMI costs would be $2,000 if you bought a $200,000 house. Lenders divide the annual PMI costs by 12 to determine how much to charge you monthly. Each year, the PMI typically drops, as the loan balance decreases.

How to Avoid or Eliminate It From Your Loan

If you want to avoid PMI on your new loan, you can by choosing one of these options. The first option is to put a larger down payment on the purchase. Lenders typically only charge PMI if you borrow more than 80% of the home's purchase price. If you put a 20% down payment on the purchase, you probably will not have PMI. The second option is to choose a loan program that does not require PMI. Other loan programs might not require PMI, but they might require other fees. Therefore, make sure you thoroughly compare your options.

If you already have a loan with PMI, you will have to continue paying it until your equity in the house rises to at least 20%. You can also eliminate PMI on an existing loan by refinancing the loan.

Paying PMI does not benefit you in any way, yet many lenders require it. If you have questions about PMI or mortgage loans, talk to a mortgage lender today.