Private Mortgage Insurance (PMI) is a type of insurance that is often required by lenders when a borrower obtains a mortgage loan with a down payment that is less than 20% of the home's purchase price. PMI protects the lender in case the borrower defaults on the loan and the home goes into foreclosure. It does not provide any direct benefit to the borrower; rather, it serves as a risk mitigation tool for the lender.
Here's how PMI works:
Low Down Payment: When a borrower makes a down payment of less than 20%, lenders consider the loan to be riskier because the borrower has less equity (ownership stake) in the property. If the borrower defaults on the loan and the home's value has decreased, the lender might not be able to recover the full loan amount through the sale of the property.
Cost and Payment: The cost of PMI can vary, typically ranging from around 0.3% to 1.5% of the original loan amount annually. The exact cost depends on factors such as the borrower's credit score, the loan-to-value ratio, and the specific terms of the mortgage. Borrowers can usually choose how to pay for PMI: as a monthly premium added to their mortgage payment or as an upfront premium paid at closing.
Cancellation of PMI: Thanks to the Homeowners Protection Act of 1998, lenders are required to automatically terminate PMI once the borrower's equity in the home reaches 22% based on the original property value. Borrowers can also request PMI cancellation once their equity reaches 20% or more. Additionally, if the home's value has increased due to market appreciation or improvements made by the homeowner, the borrower can request a new appraisal to demonstrate that the loan-to-value ratio is now below 80%, potentially leading to PMI removal.
It's important for borrowers to understand the terms and costs of PMI when obtaining a mortgage. Some mortgage programs, like those offered by the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA), have their own variations of mortgage insurance for loans with low down payments. As the housing market and regulations can change, borrowers should consult with their lenders or financial advisors for the most up-to-date information about PMI and other related matters.
