Private mortgage insurance (PMI) often is one of the costs associated with buying a home. If you make a down payment of less than 20 percent of the sale price on the home you are purchasing, the lender charges you monthly private mortgage insurance premiums. The reason is to reduce the risk associated with lending you the money. Still, it's important for you to understand how it works.
What Is PMI?
Private mortgage insurance protects the bank or mortgage company that approves you for a mortgage in the event you default on the loan. PMI is an insurance policy that will pay the lender the difference if your home goes into foreclosure and doesn't sell for the outstanding balance you owe. The insurance applies to conventional mortgage loans since government-backed mortgage programs like FHA and VA offer their own forms of mortgage insurance.
When Do Lenders Require PMI?
If you make only a small down payment, resulting in less than 20 percent equity in the home from the start, the lender will require that you carry PMI. Usually, if your loan-to-value (LTV) ratio is more than 80 percent, you must pay PMI which adds to the cost of the loan. Lenders calculate the ratio by dividing the amount of the mortgage loan by the appraised value of the home.
Therefore, if you buy a home for $185,000 and make a down payment of $9,250, you'll be putting only 5 percent down at the time of closing. Since you will need to borrow $175,750, resulting in a loan-to-value ratio of 95 percent, the lender will make you pay private mortgage insurance.
How Much Will You Pay for PMI?
The monthly premium you pay for PMI varies depending on the size of the down payment you make and the amount you borrow. A high credit score can get you a lower PMI rate as can a shorter-term loan.
An insurer bases the premium on a percentage of the original mortgage amount. Your lender then adds the amount to your monthly mortgage payment.
When Can You Cancel PMI?
Even when your loan balance reaches 80 percent, you will continue to pay PMI unless you request cancellation of the insurance. Lenders generally require that you make a cancellation request in writing.
Some lenders also require that you have a timely payment history and pay for an appraisal of the home before they cancel the insurance. An appraisal determines the current value of the home and shows that there are no liens on the property.
Once you reach a loan balance of 78 percent and owe no back mortgage payments, the lender will automatically cancel the PMI without a request from you and without an appraisal update.
To learn more about the process, contact companies like Financial One Mortgage.
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