Private mortgage insurance (PMI) protects mortgage lenders against financial losses that occur when a borrower defaults on a loan.
If you stop making monthly payments on a mortgage, you'll start getting notices from the bank, urging you to pay your outstanding balance. After 120 days of delinquency, they'll begin the foreclosure process and you'll lose ownership of the home. PMI is designed to help mortgage lenders recoup their losses when this occurs.
It's important to note the difference between PMI and mortgage protection insurance, which helps you, the borrower, continue to make payments after losing your job, becoming disabled, or passing away. During the housing crisis of 2008, 9.2% of mortgages in the U.S. were either in a stage of delinquency or foreclosure, making PMI more valuable than ever. Though the frequency of defaults has declined since then, PMI is still a necessary part of many loan agreements.
If you're financing more than 80% of your home with a conventional loan, the bank or mortgage company will most likely require you to pay PMI. In other words, if you make a down payment that's less than 20% of the home's value, the lender will want financial protection in case of a default. PMI can also be required when refinancing if your equity in the home is less than 20% at the time.
PMI usually costs 0.5% to 1% of your yearly loan balance. Once your remaining mortgage balance is 80% of the property's value, you can request that the lender cancel it. Once your remaining mortgage balance is 78% of the property's value, the lender must cancel it.
There are several ways you can pay for PMI, but the most common is through monthly premiums. This premium will be added to your regular mortgage payments, so you can pay for all the charges associated with your loan in a single recurring transaction. You can also pay for PMI upfront at closing. But keep in mind, if you later decide to refinance or sell the home, you may not be entitled to a refund.
The easiest way to avoid PMI is by making a 20% down payment at closing. If you don't have enough money saved up, ask your lender about alternative options.
In some cases, lenders will pay the PMI for you and charge higher interest rates in exchange. You could also consider putting down 5%, then paying for the additional 15% with a "piggyback" loan. Though, this has become less tolerable among lenders since the market collapsed in 2008.
Remember, some loans don't require PMI at all because they're backed by the government. If you're eligible for a VA or USDA rural development loan, you won't have to worry about hefty down payments at closing or paying for insurance each month.
To learn more about private mortgage insurance, contact The Federal Savings Bank today!