When home buyers don't put down at least 20% of the purchase price, mortgage lenders will almost always require the borrower to pay for mortgage insurance, commonly referred to as PMI (Private Mortgage Insurance). The lender forces you to purchase PMI to protect themselves in the event that you default on the loan.
Editor's note: For a PMI calculator, please visit this website. A new, improved PMI calculator will be added to this page soon. Thanks for your patience!
If you only put down 10%, or less, and the market value of your home drops 40% (as the recent housing bubble proved can happen), you might find it to be a smart business decision to just walk away from the loan, rather than continuing to pay the mortgage on a house with negative equity. A $400,000 purchase with 10% down for a $360,000 mortgage on a house now worth $200,000 is a bad investment. You may be willing to lose your $40,000 downpayment to free yourself from a loss of $200,000 at today's market price. PMI protects the lender in situations like these.
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According to the Mortgage Bankers Association of America, PMI typically ranges from .5% to 1% of the total amount of your mortgage. This figure fluctuates depending upon the size of the downpayment (closer to 20%, better the rate) as well as the credit history of the borrower.
PMI is calculated based on the total amount of your mortgage. As an example, let us assume you have pretty good credit and can get an interest rate of.5% for your PMI. Further, let us assume that the purchase price of the house was $130,000 and you were able to only put $10,000 down. You take out a 7% mortgage for $120,000 and because that is less than 20% of the sale price, you must take out mortgage insurance. The annual PMI would be $600.00 ($120,000 x .5% = $600.00), or $50.00 per month.
With a $10,000 downpayment on a $130,000 home, you are borrowing an additional $16,000 -- the difference between your $0 downpayment and the 20% downpayment necessary to avoid PMI. Know that when PMI is required, it is calculated based on full amount of the mortgage -- not just the difference between your downpayment and a 20% downpayment. In this example, if you paid only on the "extra" borrowed amount of $16,000, you'd have an annual PMI cost of $80 ($16,000 x .5%) or $6.67 per month. But in reality, the PMI will be determined based on the full mortgage value. In this scenario the PMI might work out to $50 monthly ($600 annually). Here, the PMI payment you are obligated to pay is about 750% of the amount ($6.67 monthly) you would pay based solely on the down payment difference! To make matters worse, your mortgage payments would have been lower, based on a lower amount borrowed ($104,000 as opposed to $120,000). Finally, unlike mortgage interest, you can not deduct PMI on your tax return.
Banks and other lending institutions are permitted to require you to purchase PMI if your down payment does not equal at least 20% of the selling price. If the Loan to Value ratio reaches 80%, either through appreciation of your property or if you are able to make extra payments on your mortgage, you no longer have to carry PMI.
You should notify your lender and they will review your account and, if the figures are correct, cancel your mortgage insurance. The law requires a lender to automatically cancel your PMI, once the Loan to Value ratio reaches 78%.
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There are certain exceptions where you may be required to keep PMI until your Loan to Value ratio reaches 50%. If you have taken out a high risk loan like a "No Income Verification" loan or if you have very poor credit, you may still have to pay PMI until you hit 50%. Certain FHA loans require the borrower to continue to pay PMI for the life of the loan.
Yes. Some lenders, in exchange for accepting a higher interest rate (usually .75% - 1.0%), above the rate you would receive with PMI, will waive the requirement for the insurance. Another option is taking out a small second mortgage to get you over the 80% threshold. You will pay a slightly higher interest rate on the second mortgage, but because it is usually only 10% - 15% of the total loan, the monthly payments will be fairly low. In most cases, paying a monthly payment on two mortgages comes out cheaper than paying a first mortgage and PMI, plus, it's also tax deductible.