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Private Mortgage Insurance (PMI): What It Is & When It Applies

Buyers who are not able to, or simply do not choose to put down the traditional 20% on their home loan will likely be asked to purchase something called private mortgage insurance. This allows the lender to feel safe in issuing the loan because the private mortgage insurance, also known as PMI, will cover the lender in the event that the borrower does not pay the note.

There are a few kinds of loans that do not require PMI. Government loans, like the VA Loans or FHA mortgages are insured by the government agencies that issue them and therefore do not require private mortgage insurance. And while it is an added expense for you monthly, ultimately, it saves you more money that you may realize since PMI allows you to obtain a much lower interest rate than those same lenders could give without such insurance and also to purchase a home without a large down payment.

Ways to Pay Premiums:

Depending on your personal preferences, there are some different ways to go about paying PMI premiums.

The first option is to add this expense into your monthly payments. Typically you can expect to pay about one half of one percent of the total cost of the home. For example, if your home cost $180,000, then you would pay around $75.00 per month for PMI.

If you would rather not include it monthly, you can finance PMI with your mortgage. This, however could increase your interest rate although, this type of mortgage interest is tax deductible in most cases where, PMI is not. You should talk with your loan agent as well as your tax advisor to be sure of your particular situation before making any decisions about this.

The good news is that PMI is not an expense that you will have to live with for the life of your loan. Once you have built up 20% of the purchase price in equity you can cancel the private mortgage insurance. This means that once you have either paid your mortgage payments up to this amount, once your home has increased in value, or even once you make improvements or additions to your home that equals the 20% of the purchase price, you can get rid of those PMI premiums for good. Your lender will likely require that you have another appraisal done on the home to determine the value in the event that the cancellation is due to home improvement or higher market value.

In fact, if your mortgage was established after July 29, 1999, there is a federal law that protects home owners from paying PMI unnecessarily. Once you have paid 22% of the principal of the loan, the lender must automatically cancel PMI policies. There are, of course, a few exceptions to this law, but generally speaking it works in the interest of the borrower.

One exception to this law says that if you are in arrears on your mortgage payments, your debt-to-income ratio has increased significantly or if you have a lien against the property, the lender can require you to keep your private mortgage insurance up to date.

Another option that a borrower should consider is a piggyback loan instead of private mortgage insurance. A piggyback loan will cover the remainder of the 20% down payment that the borrower does not have to put down on the home. The drawbacks include the typically much higher interest rate; however, since the interest is possibly tax deductible, this could be a nice option for you. Your loan officer or even a financial advisor will be able to help you decide which is best for your particular situation.

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