Private Mortgage Insurance- A Closer Look
Private Mortgage Insurance, also referred to as PMI, is a form of insurance that lenders need borrowers to have when they secure a mortgage and do not have adequate equity in their house. At first glance, PMI may seem like part of your conventional mortgage payment, but it’s actually a separate important risk management tool for lending institutions. It protects them from major losses in case a borrower defaults on their loan. A private mortgage insurance contract allows lenders to recover the loaned money from homebuyers even if the house isn’t worth enough to cover the balance.
It is common for mortgage lenders to ask for PMI for loans with an LTV (loan to value) percentage higher than 80%. This happens when a borrower puts down an amount that’s less than 20 percent of the property’s value during purchase. This makes a PMI useful for borrowers as well. Agreeing to cover PMI premiums allows you to buy a house without raising the full 20% down payment and make a smaller one instead.
From a financial planning perspective, it is wise to have money to put down when buying a new home. However, it can take years to get that amount. With private mortgage insurance, you get to put less money down and buy the property sooner while the lender is protected from what is considered a riskier loan. The downside is an increased mortgage payment per month as it includes the PMI premium.
How to Get Rid of PMI
Borrowers are usually only needed to keep the PMI when the LVT is less than 80%. This means that you only need to pay the PMI premiums until you have acquired adequate home equity so that the lender doesn’t consider the mortgage a high risk.
If you are currently paying private mortgage insurance premiums, there are two ways to get rid of it:
- Borrower prompted cancellation
- Automatic lender cancellation
These two options are determined by your accumulated home equity. You have the right to ask for termination or cancellation of your PMI when you have paid the mortgage to a level where it equals 80 percent of the initial buying price or the appraised value of your property at the time you secured the loan. This route requires you to manage your mortgage in an active fashion and take action when private mortgage insurance is no longer needed.
PMI policy automatic cancelation by the lender is the next option. However, the lender will not do so until you have accumulated 22 percent home equity. While you have the right to cancel private mortgage insurance at a 20% mark, the lender will not do so automatically until you accumulate the additional 2%. This means that you will be spending unnecessary money on the PMI premiums. Simply put, you will be wasting money if you do not actively manage your mortgage payments and cancel the PMI policy once you hit the 20 percent mark.
PMI can be a double-edged sword, and so, it’s important to know when you need it and the cost that comes with entering its contract.