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Basics of Private Mortgage Insurance (PMI)

October 25th, 2012 No comments

Private mortgage insurance can be an advantage to every borrower. However, borrowers need to be careful when entering into agreements which include private mortgage insurance. Generally, private mortgage insurance is designed to benefit the lender and may go too far if borrowers don’t proceed with care.

What is Private Mortgage Insurance?

In case your down payment on a home is less than 20 percent of the estimated value or sale price, you must obtain private mortgage insurance, known as PMI, with your lender. This will allow you to get a mortgage with a lower down payment as your lender is now protected against any default on the loan.PMI provides important protection for mortgage lenders

PMI charges differ depending on the size of the down payment and the loan, but they normally come to about one half of 1% of the loan, as per the Mortgage Bankers Association of America. Mortgage insurance premiums are not tax deductible.

Example, suppose that you put down 10% or $10,000 on a $100,000 house. The lender multiplies the 90 percent loan, or $90,000, by .005. The outcome is an annual PMI of $450, which is divided into monthly payments of $37.50.

The majority of home buyers need PMI because 20% of the sale price on a home is a lot of money; for instance, that’s $20,000 on a $100,000 home. Home buyers should maintain the PMI premiums until they get across that 1/5th of principal threshold, a process that can take years in longer term mortgages.

How can private mortgage insurance be a benefit to borrowers and when does it become a burden? Some of the answers to these questions can be found below.

How Will the Borrower be Benefited from Private Mortgage?

Private mortgage insurance allows low income borrowers or those who do not have large amount of readily available income—the chance to buy a home when they can only afford to put down a very small percentage on their purchase. This not only permits them to live in a home but to build equity and enjoy the benefits that come with home ownership. These benefits are big and can be a great way to buy a home.

With this type of insurance, it is possible for you to buy a home with as little as a 3% to 5% down payment. This means that you can buy a home sooner without waiting years to build up a large down payment.

However, there are some things that potential borrowers must watch out for, so that their benefits don’t turn out to be their burdens.

Drawback of Private Mortgage Insurance: What You Can Do to Avoid It

The disadvantage with private mortgage insurance is that you can get stuck paying it for much longer than you might have expected.

Private Mortgage Insurance can be a costly part of your monthly payment.Keep track of your payments on the principal of the mortgage. When you reach the point where the loan-to-value ratio hits 80 percent, inform the lender it was that is the time to put an end to the PMI premiums. The Homeowners Protection Act of 1998, which took effect in 1999, needs lenders to tell the buyer at closing how many years and months, will take for them to reach that 80% level and stop PMI. The law also mandated that once the owner had paid the mortgage down to the 78% level, then the lenders must automatically cancel PMI.

It seems like the Homeowners Protection Act has looked after a lot of headaches. It has worked to defend homeowners, though the law is applicable those who make a purchase of their home on or after July 29, 1999.

So what are the choices for homeowners who bought their homes before that date? And what about those homeowners who are working to pay down to the 78% level, but discover that it is taking a long time to do so? As per some specialists rising prices may be the answer to some homeowners’ woes.

Rising Home Prices: An Answer to Your PMI Woes?

This may not be the best key for you and your family but many homeowners find that taking benefit from the rising costs of homes is the way that they can rid of their private mortgage insurance.

How do they do this?

First they turn up with a small down payment and secure a loan with PMI. Then, after they own the home for a little while and the home rises from about 12 to 20% in value, they can refinance their home with a typical mortgage and chuck out their private mortgage insurance. This doesn’t mean that the rising prices for homes are a good thing. Many homes will often be high-priced even with mortgages offered with private mortgage insurance. However, the ‘rising home price’ choice does exist and borrowers should always know about their options.

Ways to avoid PMI

Avoid private mortgage insuranceIn today’s market there are some new ways to keep away from mortgage insurance even when you don’t have the standard 20% down payment.

Pay more interest: Some lenders will give up the mortgage insurance requirement if the buyer admits a higher interest rate on the mortgage loan. The rate increases usually from .75% to 1%, depending on the down payment. The benefit is that mortgage interest is tax deductible.

Using an “80-10-10” loan: This plan involves two loans and a 10% and a 10% down payment. The 90 percent loan is financed with a first mortgage equal to 80% of the sale price, and a second mortgage for the remaining 10%of the sale price. The second mortgage has a higher interest rate but as it applies only to 10% of the total loan, the monthly payments on the two mortgages are still lesser than paying one mortgage with mortgage insurance. In addition, there is the benefit of mortgage interest being tax deductible.