For
most
first time home
buyers, saving enough money for a sizeable down
payment is the greatest barrier to home ownership. Traditionally, lenders
have required a down payment of at least 20 percent of the home's purchase
price. However, lenders will approve a mortgage with a smaller down
payment if the mortgage is covered by private mortgage insurance.
What
is PMI and why do mortgage lenders require it?
Private
mortgage insurance is insurance that protects a lender in the event that a
homeowner defaults on a loan. Lenders generally require mortgage insurance
on low downpayment loans because experience and studies show that a
borrower with less than 20 percent invested in a house is more likely to
default on a mortgage. In effect, the mortgage insurance company shares
the risk of foreclosure with the lender.
Mortgage
insurance also enables lenders to grant loans that would otherwise be
considered too risky to be purchased by third party investors like the
Federal National Mortgage Association (FNMA) and the Federal Home Loan
Mortgage Corporation (FHLMC). The ability to sell loans to these investors
is critical to maintaining mortgage market liquidity, which in turn,
allows lenders to continue originating new loans
Payment
Options
Private mortgage
insurance can be paid on either an annual, monthly or single premium plan.
Premiums are based on the amount and terms of the mortgage and will vary
according to loan-to- value ratio, type of loan, and amount of coverage
required by the lender.
Under an annual
plan, an initial one year premium is collected up front at closing, with
monthly payments collected along with the mortgage payment each month
thereafter. Monthly plans allow a borrower to pay the lender only 1 or 2
months worth of premium at closing, and then on a monthly basis along with
the regular mortgage payment. Under a single premium plan, the entire
premium covering several years is paid in a lump sum at closing.
Typically, homebuyers choose to add the amount of the lender's mortgage
insurance premium to the loan amount. By doing this, homebuyers can reduce
their closing costs and increase their interest deduction.
Can
I Cancel Mortgage Insurance?
Mortgage
insurance can usually be canceled by the home buyer after he or she has at
least 20 percent equity in the home. Borrowers should contact their
servicer to find out the procedure for canceling mortgage insurance when
they think they have achieved 20 percent equity. Guidelines for canceling
private mortgage insurance are set by investors. Typically, investors will
require an appraisal on the property. The servicer can recommend qualified
local appraisers.
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