Buying a house is a major investment, and many people require financing to make it happen. In most cases, this means securing a mortgage, but if you are unable to put down a deposit of at least 20%, the lender will require you to take out private mortgage insurance (PMI). This article will explain what PMI is, how it works, and why it might be right for you.
What is Private Mortgage Insurance (PMI)?
Private Mortgage Insurance (PMI) is a type of insurance that protects lenders from borrower defaults in case of non-payment of the mortgage. PMI is typically required when borrowers put less than 20% down on their homes. The insurance policy is usually provided by a private insurer and is paid for by the borrower, either on a monthly or up-front basis.
PMI is different from homeowner’s insurance, which covers damages and losses to the property itself. Instead, PMI is designed to protect the lender’s investment in the event that the borrower defaults on their mortgage payments.
When Is Private Mortgage Insurance Required?
PMI is typically required when borrowers make down payments of less than 20% of the home’s purchase price. This can be a significant amount of money, and many people choose to take out PMI in order to qualify for a mortgage loan.
For example, if you are purchasing a $300,000 house and are only able to put down $30,000 (or 10%), your lender will require you to take out PMI. The exact amount of PMI you will need to pay will depend on the size of your down payment and the value of your home.
It is worth noting that some lenders require PMI even if you put down 20% or more on your home. This is because they view these borrowers as riskier than those who put down larger amounts of money, and they want to protect their investment in case of default.
How Does PMI Work?
Private mortgage insurance works by providing a safety net for lenders in case borrowers default on their mortgage payments. If the borrower stops making their payments, the lender can file a claim with the insurer to recover any losses incurred as a result of the default.
If a borrower has PMI, the premium is typically added to the monthly mortgage payment. This means the borrower pays a little extra each month to ensure that the lender is protected in case they are unable to make their payments.
Types of Private Mortgage Insurance (PMI)
There are two types of private mortgage insurance: borrower-paid mortgage insurance (BPMI) and lender-paid mortgage insurance (LPMI).
Borrower-Paid Mortgage Insurance (BPMI)
BPMI is the most common type of private mortgage insurance. With BPMI, the borrower is responsible for paying the insurance premium. Typically, BPMI is paid monthly as part of the mortgage payment or as an upfront fee at closing.
The cost of BPMI will depend on a number of factors, including the size of the down payment and the length of the loan. The standard rate for BPMI is between 0.3% and 1.5% of the original loan amount.
Lender-Paid Mortgage Insurance (LPMI)
LPMI is less common than BPMI, but it can be a good option for some borrowers. With LPMI, the lender pays the insurance premium, but the cost is typically reflected in a higher interest rate on the mortgage.
The advantage of LPMI is that the borrower does not have to make a separate monthly payment for the insurance. However, the downside is that the borrower will end up paying more over the life of the loan due to the higher interest rate.
Benefits of Private Mortgage Insurance (PMI)
Allows Borrowers to Purchase a Home with a Low Down Payment
The primary benefit of PMI is that it allows borrowers to purchase a home with a low down payment. Without PMI, many people would be unable to afford a home, as a 20% down payment can be a significant amount of money.
By paying a little extra each month for insurance, borrowers can get the financing they need to buy a home and start building equity.
May Be Tax-Deductible
Under certain circumstances, PMI premiums may be tax-deductible. To qualify, you must have taken out the mortgage after January 1, 2007, and your annual income must be below a certain threshold.
You should consult with a tax professional to determine whether you are eligible for this deduction and how much you can claim.
Disadvantages of Private Mortgage Insurance (PMI)
Adds to the Overall Cost of the Mortgage
One of the biggest disadvantages of PMI is that it adds to the overall cost of the mortgage. Depending on the size of the down payment and the length of the loan, PMI premiums can add up to thousands of dollars over the life of the loan.
For some borrowers, this extra cost may be prohibitive, and they may be better off waiting until they can afford a larger down payment.
May Be Difficult to Cancel
Another potential disadvantage of PMI is that it can be difficult to cancel. Under federal law, lenders are required to cancel PMI once the borrower has paid off 22% of the original loan amount.
However, many lenders have their own rules regarding PMI cancellation, and it can be difficult to get them to agree to cancel it early. This means that borrowers may end up paying for PMI for longer than they need to.
FAQ – Frequently Asked Questions About Private Mortgage Insurance (PMI)
Question |
Answer |
|---|---|
What is Private Mortgage Insurance (PMI)? |
PMI is a type of insurance that protects lenders from borrower defaults in case of non-payment of the mortgage. PMI is typically required when borrowers put less than 20% down on their homes. |
Do I Have to Get Private Mortgage Insurance? |
If you make a down payment of less than 20% on your home, your lender will require you to take out PMI. Some lenders may require it even if you put down 20% or more. |
What is Borrower-Paid Mortgage Insurance (BPMI)? |
BPMI is the most common type of PMI. With BPMI, the borrower is responsible for paying the insurance premium. Typically, BPMI is paid monthly as part of the mortgage payment or as an upfront fee at closing. |
What is Lender-Paid Mortgage Insurance (LPMI)? |
LPMI is less common than BPMI, but it can be a good option for some borrowers. With LPMI, the lender pays the insurance premium, but the cost is typically reflected in a higher interest rate on the mortgage. |
How Much Does PMI Cost? |
The cost of PMI will depend on a number of factors, including the size of the down payment and the length of the loan. The standard rate for BPMI is between 0.3% and 1.5% of the original loan amount. |
Is PMI Tax-Deductible? |
Under certain circumstances, PMI premiums may be tax-deductible. To qualify, you must have taken out the mortgage after January 1, 2007, and your annual income must be below a certain threshold. |
Conclusion
Private Mortgage Insurance (PMI) is a type of insurance that protects lenders from borrower defaults in case of non-payment of the mortgage. PMI is typically required when borrowers make down payments of less than 20% of the home’s purchase price.
While PMI can be a useful tool for those who are unable to make a large down payment, it adds to the overall cost of the mortgage and can be difficult to cancel. Borrowers should carefully weigh the pros and cons of PMI before deciding whether to take it out.