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The Nuts and Bolts of Private Mortgage Insurance (PMI)

If you plan on having less than a 20% down payment on your home, you may have to budget a little extra for Private Mortgage Insurance (PMI). There’s a lot you should know about this coverage – though it is required for some, it is also quite possible you’re paying premiums that may no longer be necessary.

What PMI is…
Mortgage Insurance is a policy that protects lenders against some or most of the losses that may result from a default on the home loan. It is required of borrowers that plan to make a down payment of less than 20%. These days, many first-time homebuyers are putting far less than 20% down, making this coverage increasingly popular. The lower your equity, the greater the LTV (Loan-to-Value) ratio on the mortgage. And the greater the LTV, the greater the risk of the loan to the lender. The goal of PMI, therefore, is to reduce the default risk for the lender, which in turn allows the borrower to use less money on a down payment.

What PMI is not…
PMI should not be confused with homeowners insurance. Homeowners insurance protects your assets; including the home, the property, and its contents (depending on your policy). PMI also should not be confused with mortgage life, credit life or disability insurance. These are designed to pay off a mortgage loan in the event of the borrower’s death or disability. The key difference is that these coverages are designed to protect you and your family. PMI is a tool designed to protect the lender.

How does it work?
Like other typical insurance policies, PMI requires payment of a premium. You may be billed monthly, annually, or by an initial lump sum for your premium. In many cases, the lender will package this premium payment in with your other tax and insurance escrow payments. Your premium is usually based on the balance of your mortgage loan, so as the balance is paid down, the premium may decrease. If the borrower can’t repay the insured loan, the lender may foreclose on the property and file a claim with the mortgage insurer for any loss incurred by the lender.

LPMI is Lender Paid Mortgage Insurance. As the name suggests, this program has the lender purchase the mortgage insurance and pay the premiums. The lender will increase your interest rates to pay for the premium, but LPMI may reduce your settlement costs.

Do I always pay PMI?
Private mortgage insurance was designed to protect the lender from loss and allow the borrower to put less money down. As time goes on, the loan gets paid down while the value of the property may be increasing. That means the homeowners are building more equity in the home. So what happens after the homeowners build their equity up greater than 20% of the home’s value? Depending on when you purchased the home, PMI may be canceled by the lender or applied for cancellation by the borrower. (LPMI or government mortgage insurance can not be cancelled during the life of the loan). Before you commit to paying mortgage insurance, find out the requirements for cancellation.

Finally, it is important to note that PMI premiums may become unnecessary sooner than you think. If property values are increasingly rapidly in your neighborhood, you may achieve 20% home equity faster than you initially predicted. If you feel the value of your home has risen substantially, and that PMI is no longer required, visit with your credit union’s mortgage department. It is possible that they’ll recommend a re-appraisal of your home.

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