The Facts and Fiction of PMI

September 15, 2016

When you start shopping for a mortgage, you’ll undoubtedly hear about PMI, which stands for Private Mortgage Insurance. Here are some facts you should know about PMI:

PMI protects the lender. – Many borrowers don’t realize that PMI is for their lender, not for them. The purpose of PMI is to protect lenders from borrowers who default, i.e., those stop paying their mortgage.

Not all borrowers have to pay PMI. – Many home buyers assume that they will have to pay PMI, but that isn’t the case. PMI is usually required only if your down payment is less than 20% of the home’s value. Additionally, some types of loans, such as FHA and VA loans, require other types of mortgage insurance but not PMI.

Some borrowers avoid paying PMI by taking out a second mortgage for the amount needed to make a 20% down payment on their first mortgage. It is important to note that the interest rate on a second mortgage is almost always higher than the interest rate on the first mortgage.

PMI is tax deductible. – Prior to 2007, PMI was not tax deductible. Therefore, the second mortgage option was more attractive because the interest paid on a second mortgage is tax deductible. PMI became tax deductible in 2007, but the deduction must be renewed each year by Congress, so it is not guaranteed.

PMI adds hundreds of dollars per month to your mortgage payment. – The cost of PMI generally runs between 0.3% to 1.5% of the original loan amount, per year, or approximately $25 to $125 per month for every $100,000 borrowed. The rate used to calculate your PMI will be based in large part on your credit score, the size of your down payment, and the loan to value ratio (i.e., the amount that you are borrowing divided by the value of the property).

PMI must be paid every month. – While PMI is usually paid monthly along with your monthly mortgage payment, many lenders will allow you to pay it as a lump sum at closing.

PMI can be canceled. – Contrary to what many borrowers believe, you don’t have to pay PMI for the life of the loan. Most mortgages are structured so that PMI automatically terminates when the balance on the loan is 78% of the original value of the property (i.e., you have 22% equity) according to the original amortization schedule. If you reach 20-22% equity prior to the date on the original amortization schedule (because you made extra payments or the value of your property has increased), and you are current on your payments, you can submit a written request to terminate PMI early. Your request will likely need to be supported by evidence such as an appraisal of the home’s current value.

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