What is PMI and how can I avoid paying it?
Thursday, 9 January 2020
When you take out a mortgage to purchase a home, you may be required to pay for private mortgage insurance (also known as PMI).
This is basically an insurance policy designed to protect the lender if you default on your loan.
The modern PMI industry began in 1957 when the Mortgage Guaranty Insurance Company (MGIC) was formed. While some firms offered mortgage insurance in the early 1900s, those firms went bankrupt during the Great Depression in the 1930s. The Federal Housing Administration (FHA) started an insurance program and other public housing programs in 1934, but there were no insurance programs for private mortgages.
With no mortgage insurance to protect them, banks required every borrower to make a down payment of at least 20 percent of the purchase price of the property. But when MGIC began providing mortgage insurance, essentially assuming the risk on the first 20 percent of loan losses, borrowers were able to make lower down payments in exchange for monthly insurance payments. Today, PMI works in much the same way: Borrowers who put less than the customary 20 percent down are typically required to purchase mortgage insurance to cover potential losses for the lender.
How much does PMI cost?
In most cases, PMI is calculated as a percentage of the mortgage loan amount, usually between .3 percent and 1.5 percent of the original loan. The price varies based on the size of the borrower's down payment and credit score.
PMI is usually paid on a monthly basis as part of your mortgage payment. So if your original mortgage was $100,000 and your PMI is 1 percent per year, you would pay $1,000 per year, or $83.33 each month, for the coverage. This amount would be added to your regular monthly mortgage payment.
How to avoid — or stop paying — PMI
Most mortgage lenders require borrowers to pay PMI when their down payment is less than 20 percent of the price of the home. So you can avoid paying PMI saving up enough money to put 20 percent down.
However, even if you were required to purchase PMI when you got your mortgage, you don't have to pay it for the entire term of your loan. Lenders will remove the PMI requirement once your loan balance drops to 78 percent of your home's original appraised value. But you must meet certain requirements such as being current on your payments before PMI can be removed.
So watch your monthly statement and keep track of how much you've paid on the principal balance of your mortgage. When your payments equal 22 percent of the purchase price, talk to your lender about cancelling your PMI.
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