What Is Private Mortgage Insurance?

Private mortgage insurance or PMI as is known is a form of insurance that most of the new homeowners are required to purchase. This is particularly so that if their down payment is 20 percent or less of the valued price or sale price of a particular property.

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The main reason for the private mortgage insurance is to protect lenders in the case the new homeowner defaults on their home loan.

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Since private mortgage insurance only protects lenders, it has a bad reputation overall, but actually it is a good thing. The reason is that it has allowed millions of people to be able to buy homes with smaller down payments. Previously, these people would not have been able to afford to buy a home had the down payment remain the same. To qualify for home loans, private mortgage insurance can help you achieving, which is another important reason that you should have this life insurance.

Cost of Private Mortgage Insurance

Depending on the mortgage loan and the monthly down payment, there can be variation in the cost. Usually, it is half a percent. The following estimated formula can help you calculate your private mortgage insurance:

Annual private mortgage insurance = 100 – (percentage of down payment paid) * (sale price of house) * 0.05

Let us take an example. Suppose you brought a $500,000 house. You pay a 2 percent down payment. So using the formula as defined above:

Annual private mortgage insurance = (100 – 20) * $500000 * 0.005 = $2000

Your monthly mortgage insurance, dividing by 12, will be around $167.

One important point to be noted is that you should always keep track of your payments and notify your lender when you have reached 80 percent equity of your house. Even though the Homeowner Protection Act requires lenders to notify you of how long it will take you to pay, it is still better to keep track of it yourself.

There are some cases where the homeowners are allowed to continue, by their lenders, their private mortgage insurance all the way through the lifetime of the loan. This usually applies to high risk borrowers. Therefore your payment history and credit rating such as your FICO (Fair Isaac Corporation) score plays an important part in this as well.

Some people do not like paying private mortgage insurance for years. There are some ways around it.

One way is to pay your home loan with higher interest rate. If you agree to pay a higher interest rate, some lenders will waive the private mortgage insurance requirement. To go on ahead, it can be a good idea as mortgage interest is tax deductible.

Another way to avoid paying private mortgage insurance is that you can prove the lender the fact that the value of your home has risen. If the value of your home has risen significantly, your home has already had the 20 percent or more equity that you need to cancel the mortgage insurance. However, it does take time for the lender to verify your claim, sometimes as long as a year.

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