PMI, also known as private mortgage insurance, is a lender’s protection in the event that you default on your primary mortgage and the home goes into foreclosure. This is exclusively for the lender’s protection. Banks don’t like losing money, who does? They have determined that they can recover about 80% of a home’s value at a foreclosure auction if the buyer defaults and the bank has to seize the house.
If you fall behind on your payments, PMI will not protect you and you can lose your home through foreclosure.
When home buyer applies for a conventional loan a lender will feel more comfortable if they are able to put down at least 20%. If this is not possible, a lender will typically look at the loan as a riskier investment and require that the borrower take out PMI.
Note: Your loan estimate and closing disclosures will list PMI as part of your payment. Most of the times, this fee is paid monthly but on occasion you will see the fee listed as an up-front premium. Sometimes you will see a combination of month and up-front fee.
The PMI is usually paid monthly as part of the overall mortgage payment to the lender. PMI may cost between 0.5% and 1% (depending on the type of loan) of the entire mortgage loan amount annually. For example: assuming your PMI is a 1% on a $200,000 loan. That fee would add approximately $2,000 a year, or $166 each month, to the cost of your mortgage.
PMI can sometime be cancelled once you have reached loan balance of 80% of the loan balance. You might have to contact your lender and request that the PMI payment be removed. Keep in mind that the lender might have other conditions, such has no past due payments. Normally the bank will require that your home be appraised before they would consider removing this fee.
Look for Mortgage Insurance Premium (MIP). If you are an FHA-insured borrower, the Mortgage Insurance Premium (MIP) you pay as a part of your monthly mortgage payment is what makes the reduced downpayment on your mortgage possible. FHA uses these payments to insure your lender against losses if the loan goes to foreclosure.
Borrowers can request that monthly mortgage insurance payments be eliminated once the loan-to-value ratio drops below 80%. Some loan servicers will allow (but are not required) borrowers to cancel PMI sooner based on home value appreciation. If the borrower accumulates 25% equity due to appreciation in years two through five, or 20% equity after year five, the investor who purchased the loan may allow PMI cancelation after the home’s increased value is proved with an appraisal.
An alternative to PMI, is a second loan to cover the 20%. A second mortgage will typically come with a higher interest rate.
Make extra payments towards you principal balance. Not only will this get you to the 80% balance faster but it will save you a tons in interest. Even the smallest payments makes a huge difference.