What Prospective Homebuyers Need To Know About Private Mortgage Insurance

As a real estate agent, I often come across homebuyers—and prospective homebuyers— wondering about private mortgage insurance and whether it's worth it. The short answer is: in most cases, no. 

Private mortgage insurance, also known as lenders mortgage insurance, is the insurance you will have to pay when you have a conventional loan (i.e. loans with a fixed rate not insured by government agencies like the VA) and are putting down less than a 20 percent as a down payment. Nearly every lender requires private mortgage insurance when a borrower does not reach the twenty percent threshold.

If you're deciding between a conventional mortgage and a government-backed mortgage, PMI is a critical expense to account for.

So why do lenders require borrowers to purchase private mortgage insurance anyway? The reasoning is simple. In the unfortunate event you end up in foreclosure, PMI ensures lenders don't lose their money.

From a buyer's perspective, however, PMI is useless, as it does not help you build equity or do anything remotely special for you.

Putting Less Money Down

If you're in a position where you're in a hurry to become a homeowner but cannot afford the 20 percent down payment, you're going to get saddled with PMI. This is when you should consider going to a government-sponsored group for your mortgage financing (such as the FHA, USDA or VA), which will help you avoid paying private mortgage insurance to begin with. You might also be able to find a local lender who holds their money in-house and does not require the insurance.

But just because these two alternatives will save you money on PMI, you need to make sure the terms and costs of these government programs are still better than the conventional method. It doesn't make sense to avoid private mortgage insurance if you end up paying more out of your pocket in the long run. Have the mortgage lender do a detailed overview of your costs before making a final decision.

What You Need to Know to Cancel Your Private Mortgage Insurance Policy

While the benefits of quickly becoming a homeowner and numerous, there can be downsides.

Even if getting private mortgage insurance is the only way you can qualify for a mortgage, it may be smart to reconsider. To help put things into perspective, the average PMI premiums range between 0.5-1 percent. Let's say your home costs $150,000. A 10 percent down payment will bring your balance to $135,000. Based on that figure, your PMI premium can be anywhere from $675-$1,350. Again, this is money that protects the lender, not you. 

The good news is there are several ways to get out of your PMI thanks to the Homemakers Protection Act of 1998. Achieving 22 percent equity grants automatic cancellation of the policy, while achieving 20 percent equity allows you to cancel the policy yourself (though you have to initiate the cancellation with the lender). Your PMI policy can't be canceled if there are liens against your property and your payments are not current.

What to Do Before Choosing A Mortgage Lender

While choosing a specific loan program is a critical exercise, you don't want to put the cart before the horse. One of the things I always recommended to my clients before buying a home is getting their financial house in order. Before picking a lender to work with, you should be building your credit and preparing a financial budget that you'll be able to live with comfortably.

Additionally, buyers need to be cognizant not to do anything that will lower their credit scores before purchasing a home. The best credit scores translate into the best mortgage rates and terms. Opening new credit cards and carrying a credit balance are sure-fire ways a credit score can drop. 

So, To Recap:

• PMI is required by buyers when putting less than a 20 percent down payment on a home.
• Private mortgage insurance benefits a lender, as it protects them in the event of default.
• You can stop paying private mortgage insurance when you reach 20 percent equity in your home.
• To stop paying private mortgage insurance, you need to contact your current mortgage holder.
• By law, mortgage companies have to automatically remove private mortgage insurance when equity in a home reaches 22 percent.

Hopefully, you now have a firm grasp on how to terminate your private mortgage insurance payments.