Private Mortgage Insurance
Private mortgage insurance (PMI) helps you get into a home faster. Why? Because it allows you to buy with less than 20 % down, but still reduces the risk to your lender so that you don't have to pay higher rates of interest.
Now why do lenders want 20% down? That magical 20% generally assures the lender that if the lender has to foreclose, the lenders loss will be completely recovered.
Having said that, if lenders exclusively gave mortgages to folks with 20% down, there would be a lot of us who would be renting. (My first home was purchased with mortgage insurance. I only had about 10 % down.) With so few people able to qualify to get mortgages, the demand for houses would be MUCH less.
Lets face it: saving up 20% of the purchase price of a home is a BIG chunk of money. Most of us would have a hard time doing it. If you were looking at buying a home worth $300,000 that would mean you'd need $60,000 in savings! It's a huge challenge.
So, what do you do? You get private mortgage insurance. Here are the basics of how it works: You get a policy. Then, you purchase your $300,000 home with less than $60,000 down (assuming you can qualify for the mortgage amount). Your PMI policy provides a guarantee to your lender that if you default, the insurance policy will compensate for much or all of the loss to them. And you become a homeowner.
In effect, you buy now, buy with what you have, and use PMI instead of a hefty down payment.
There are various PMI plans and they typically work like this:
- The more you put down, the less coverage you need. In other words, more insurance is required with 5 percent down, less insurance with 15 percent down.
- Adjustable-rate mortgages, ARMs, are perceived as more risky than fixed-rate loans, thus PMI costs are somewhat higher.
- The borrower pays for PMI coverage, but if the loan is defaulted, the lender is the policy beneficiary.
You do have to keep in mind that it is possible for a lender to conditionally approve a loan, and also for a PMI company to decline coverage. It's best to have ensure you qualify for the mortgage amount as well as for PMI coverage before you start to shop for a home, if you want the best outcome.
PMI will cost you money. In most cases, you will pay a monthly premium based on the amount of outstanding mortgage debt. This can add up, so it is not necessarily a cheap alternative to saving up to buy a home. But, it does get you in the market sooner and with housing prices generally on the rise, sooner can be a good thing.
When does your PMI coverage (and premiums) end? This can depend on how aggressively you pay your mortgage. The HomeOwners Protection Act of 1998 (HPA provides that if the borrower has a good payment history, then once the original debt has been reduced 22 percent, PMI must be cancelled. Further, the rules also allow borrowers to request PMI cancellation after they have reduced their loans 20 percent.
However, if you have refinanced a home that has greatly appreciated, you may be able to get your PMI coverage cancelled early. And the good news is that many loans now allow for early PMI cancellation. In most cases, in order to get PMI cancelled, you will need to get an appraiser to verify the value of your home. With some lenders, if you have a good payment history, and if the loan-to-value ratio of your home is not greater than 80 percent (with your new appraisal), then there is a good case to cancel PMI coverage. However, a good payment history means that you must have established a record of paying on time with your lender. This period can vary; it will depend on the lender as well as on how much equity you have managed to get (through both payments or appreciation) in your home.
To get PMI cancelled early, you must take the initiative and contact the lender who collects your payments. Ask who owns your loan. Check the policies of the loan holder. Many are also updating PMI cancellation standards.