PMI, or Private Mortgage Insurance, is an insurance policy that protects the lender if a borrower defaults on their mortgage. It's an extra monthly expense typically required for conventional mortgage borrowers who make a down payment of less than 20% of the home's purchase price.
Here's a more detailed breakdown:
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Purpose: PMI is designed to shield the lender from financial loss if the borrower stops making mortgage payments. Although the borrower pays for it, the beneficiary is the lender.
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When it's Required: You'll generally need to pay PMI if your down payment is less than 20% of the home's value. Lenders see a lower down payment as a higher risk.
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How it Works: PMI is usually added to your monthly mortgage payment. The cost varies depending on factors such as your credit score, loan amount, and down payment percentage.
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Cost of PMI: The annual cost of PMI typically ranges from 0.5% to 1% of the original loan amount. This cost is then divided into monthly payments. For example, on a $200,000 loan, PMI could cost between $1,000 and $2,000 per year, or roughly $83 to $167 per month.
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How to Avoid PMI:
- Save for a Larger Down Payment: Aim for a 20% down payment to avoid PMI altogether.
- Consider a Piggyback Loan: A piggyback loan (also known as an 80/10/10 loan) involves taking out a second mortgage to cover part of the down payment, effectively reducing the need for PMI.
- Explore VA or USDA Loans: These government-backed loans often don't require PMI, although they may have other fees.
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Canceling PMI: For conventional loans, PMI can often be canceled once you reach 20% equity in your home, either through paying down the mortgage or through appreciation in the home's value. You may need to request the cancellation in writing. By law, PMI must automatically terminate when your loan balance reaches 78% of the original value of the home, provided you are current on your payments.
In summary, PMI is a cost associated with mortgages that protects the lender in case of borrower default, generally applying when the down payment is less than 20%. It can be avoided or canceled under certain circumstances.
