Private mortgage insurance, commonly referred to as PMI, is insurance which borrowers have to pay in case they cannot afford to pay a 20% down payment. As a borrower, it will cost $50 to $80 monthly. Mortgage insurance reimburses the lender if you default on your home loan. However, it can sometimes become a burden for the borrowers, especially if they do not proceed carefully. As it is based on a percentage of the mortgage loan, borrower is expected to pay each month, it varies depending on borrower’s credit risk and the size of his home loan.
2 Types of Private Mortgage Insurance
Private Mortgage Insurances can be classified into 2 broad categories – Borrower-paid PMI and Lender-paid PMI.
Borrower-paid Private Mortgage Insurance
This type of PMI is where the borrower has to pay insurance premium. Usually, borrower is required to purchase this insurance policy when he is unable to afford the 20% down payment on his home loan. It is also known as Traditional Mortgage Insurance.
Lender-paid Private Mortgage Insurance
The lender-paid PMI is the type where the lender pays the PMI premium cost of PMI but the borrower must bear the premium cost. Most lenders tend to add the extra expense of premium cost to the mortgage loan interest. Lender generally buys the lender-paid PMI policy for high loan-to-value mortgage.
Advantages of Private Mortgage Insurance for the Borrower
It has been established that there are risks associated with private mortgage insurances for the borrowers, which will be discussed in details in a later section. However, there are some up-sides of these insurances as well. One of the biggest reasons why borrowers choose this is because it allows the low income borrowers or borrowers who are in need for large amount of fund the opportunity to buy a home. Even when the borrowers can pay only a small percentage of the total cost, they can but the home.
In addition to providing shelter, this also helps build equity. They are able to enjoy all benefits as homeowners.
Disadvantage of Private Mortgage Insurance and Ways to Avoid Them
While is seems like a great idea for both lenders and borrowers, there are some downsides associated with PMIs. As a borrower, you may have to pay for a longer period than expected. Some lenders may require you to maintain a PMI contract for a fixed period of time. So, even after you meet the 20% threshold, you may be obligated to continue paying for the insurance.
These insurances are hard to cancel and eliminating the monthly burden is not as easy. The lender might want you to to draft a letter requesting to cancel the PMI. Depending on the lender, the process may take a few months.
Ways to Avoid Risks of Personal Mortgage Insurance
Even though the risks are evident, more and more people are getting personal mortgage loans. They cave in to their financial needs. There are 3 main ways to avoid the risks associated with personal mortgage insurances. They are:
- Make a down payment which is equal to minimum 20% of the home’s purchase price.
- Rely on a piggyback mortgage
- Get a lender-paid mortgage insurance
It is true that Private mortgage insurances are expensive. If you are not confident that you will be able to get 20% equity in the home in a few years, it is suggested to either consider a piggyback loan or give a larger down payment. piggyback loans might be riskier than traditional alternatives but they are tax deductible.
Before making the final decision, assess both the positives and negatives of getting a Private Mortgage Insurance.