What is PMI?

Just when you thought you had all the parts of a potential mortgage payment figured out, you come across the term PMI, and now you're confused again.  Primary Mortgage Insurance, more commonly known as PMI, is a way for a lender to help reduce their risk in the event that you default on your mortgage.

The industry standard for a down payment is typically 20%, but you've read our website and know that you don't have to be able to put down 20% to qualify for a mortgage.  While it is great from a buyer's standpoint that you don't have to put this amount down, it inherently increases the lender's risk.  To help the lender mitigate their risk, they require that you take out PMI.

So how does PMI work?  PMI works just like any other insurance policy.  You have an asset (your mortgage) that you would like to insure against a possible loss (you defaulting on your payments), so you pay premiums to a third-party company that guarantees some value for the asset*.  This insurance makes lending to you less risky to the lender because they now have a second way to recoup their money (the first being to sell your home).

Whether you put down 0% or 19%, chances are the lender will require you to have PMI.  This is important because it can have a significant impact on the size mortgage you are able to afford.  PMI payments are typically made directly to the lender and can range from from $30 to over $200 per month.  That's huge!  $200/month is almost the equivalent of an extra $50,000** on the purchase price of a house!

While the thought of paying extra money is never exciting, don't let the knowledge of PMI keep you from buying a home.  If it makes sense for you to buy a home, and you don't have 20% to put down, PMI is wonderful in that it allows lenders to feel comfortable enough to lend to you.  You just have to make sure that you remember to include this payment when budgeting for your monthly cost of home ownership!

One last note on PMI.  You do not have to carry this insurance for the length of the loan!  The lender is required by law to remove the PMI on the date that your loan is scheduled to only have 78% remaining on it's equity balance.  But you don't have to wait until this date to have the PMI removed.  It is possible that you make a written request to have this payment dropped by the lender if the value of your property has significantly increased.  This process varies depending on the policy, but you typically would need to prove the homes increased value (appraisal).  Likewise, it might make more sense for you to refinance your mortgage.

So, there you have it.  PMI is just another part of the puzzle known as home ownership!



*Since the insurance is technically for the lender, that is why your mortgage is considered an asset and you defaulting is what they are insuring against.

**This is calculated at an interest rate of 4.5%.

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