What is Private Mortgage Insurance (PMI)?
When we talk about purchasing insurance, it’s usually about purchasing coverage to protect ourselves against future unforeseen events. Health care crises, automobile accidents and the like. Sometimes, insurance coverage is required (like in the case of auto insurance and health insurance), and often it’s optional (like in the case of life insurance, disability insurance, etc.). But what about Private Mortgage Insurance, or PMI – is it coverage that protects homeowners, and is it optional to purchase?
What is PMI and how does it Work?
Unlike the examples above, PMI is private insurance on your mortgage, which you pay for, and which protects your mortgage lender in the event that you stop making your monthly payments. PMI premiums are generally billed on a monthly basis, and will be added to your monthly mortgage bill, along with taxes and homeowners insurance. When a bank or mortgage lender extends you a mortgage loan on a home, they are taking on financial risk as well – the risk that for any number of reasons, you will default on your loan. The more money you put down at the time of sale, the less the risk to the lender. Conversely, if you are only putting down 5% of the cost of the home, the lender is taking on an increased risk. When lenders take on additional risk, they want to secure additional guarantees from the borrower (you), and one of those guarantees is PMI.
Your mortgage lender will likely require you to have PMI if you put down less than 20% of the sales price or the appraisal value of your new home. While some lenders are willing to waive PMI with down payments of 10% or more, the general rule is that if you put down less than 20%, you will be required to carry PMI on your loan until the amount due on your home reaches 80% of the loan to value of your home.
Some lenders have a “buy-out PMI” loan option for credit-worthy borrowers who don’t have the cash on hand to put down 20%, but also don’t want to pay PMI each month. These loan options will almost always be at higher interest rate than the loan you would qualify for with PMI – often about .5% higher.
Can You Decline PMI?
No. If your mortgage lender requires you to carry PMI on your mortgage loan, it will be a non-optional loan requirement. You can request that your lender cancel the PMI once your loan amount due is equal to 80% of your home’s current value, and PMI will automatically cease when your outstanding loan amount due reaches 78% of your home’s value. You may only be able to request the early cancellation of your PMI if you have been, and are current on your monthly mortgage payments.
One final tip: Don’t confuse PMI with “mortgage life insurance”, which is totally optional additional insurance coverage that homeowners can purchase. Mortgage life insurance is an insurance product which will pay off your mortgage in the event of your death (and in some cases, in the event of severe disability).