Why does private mortgage insurance exist?
If you don’t have a lot of money to put down on a mortgage, you will probably be required by your Lender to pay for private mortgage insurance. Many Lenders would otherwise be unwilling to take on the risk of a loan with a down payment lower than 20% of the appraised value or sale price of a home (usually using whichever is the lower of the two). The private mortgage insurance protects the lender in case of default by the borrower. It’s important to remember that while the borrower pays the premiums, the lender is the sole beneficiary of the insurance.
There are two types of mortgage insurance: Government (primarily Federal Housing Administration) and private. Different rules apply to each type, so it’s important to know the facts before you apply for a loan. FHA loans will often require the mortgage insurance to be paid for a minimum of 5 years with a minimum loan-to-value ratio of 78%. Whereas private mortgage insurance may be eliminated once the loan-to-value ratio reaches 78% or more.
As stated earlier, you will be required to have mortgage insurance if your down payment falls below 20% of the appraised value or the sale price of your home. FHA loans are available for borrowers with as little as 3.5% down. Conventional will usually require a minimum of 5% down. Some lenders advertise no-mortgage insurance required loans. What this really means is there is a lender paid mortgage insurance that, although a borrower does not see it, will be funded through a higher interest rate charged to them, and they cannot cancel the insurance.
Fees for mortgage insurance currently range from as low as 0.5% to as high as 6% of the principal loan amount. The amount charged will vary depending on such factors as the size of your down payment, the loan am
ount, the loan-to-value (LTV) ratio, occupancy (whether it is a primary home, secondary home, or investment property), and your credit score. The PMI may be paid up front in a single lump sum, paid annually or monthly, or may be capitalized onto the loan. The premiums are currently tax deductible.
The US Homeowners Protection Act of 1998 allows borrowers to request cancelation of PMI when the LTV is reduced to 80%. The law requires that lenders tell borrowers at closing how many years and months it will take for their loan to reach the 80% level. FHA loans are not required to remove PMI under the same rules as a conforming, or conventional loan. A borrower will also want to keep track of their own mortgage especially if they make additional monthly payments or take actions that increase their home equity. In addition, removing the PMI may have requirements suc
h as at least two years on-time payments, or if there is a 2nd mortgage, the total loan to value betweenthe 1st and 2nd may not be more than 80% loan-to-value. The law requires lenders to automatically cancel PMI when the balance hits 78% of LTV. State laws may vary on this, so it is a good idea to check with your own state. If your property value increases, you may also have your home reappraised, and if the new LTV is 80% or less, you may request cancelation of the mortgage insurance. You may also choose to refinance, making sure that your equity is at least the required 20% or more.