Private Mortgage Insurance - PMI
Definition of 'Private Mortgage Insurance - PMI'
A risk-management product that protects lenders against loss if a borrower defaults. Most lenders require private mortgage insurance (PMI) for loans with loan-to-value (LTV) percentages in excess of 80% (the buyer put down less than 20% of the home's value upon purchase). This allows borrowers to make a smaller down payment of 3% to 19.99%, instead of 20%, allowing them to obtain a mortgage sooner since they don’t have to save up as much money. Borrowers pay their PMI monthly until they have accumulated enough equity in the home that the lender no longer considers them high risk.
Investopedia explains 'Private Mortgage Insurance - PMI'
PMI only applies to conventional loans. Federal Housing Administration loans have their own mortgage insurance with different requirements, while Veterans Administration loans don’t require any mortgage insurance despite allowing 0% down payments.
PMI costs about 0.25% to 2% of your loan balance per year, depending on your down payment, loan term and credit score. The greater your risk factors, the higher the rate you pay. Also, because PMI is a percentage of the loan amount, the more you borrow, the more PMI you’ll pay. There are six major PMI companies in the United States. They charge similar rates, which are adjusted annually.
Keep track of your payments on the mortgage’s principal. When you reach 20% equity, you can notify the lender in writing that it is time to discontinue the PMI premiums. Lenders are required give the buyer a written statement at closing notifying them how many years and months it will take for them to pay 20% of the principal. You can also request PMI cancelation if your equity grows to 20% due to home-price appreciation or because you’ve made additional principal payments. The lender should comply as long as your home’s value hasn’t dropped, you have a history of on-time payments and you don’t have a second mortgage.
Once your down payment, plus the principal you’ve paid off, equals 22% of the home’s purchase price, the lender must automatically cancel PMI as required by the federal Homeowners Protection Act, even if your home’s market value has gone down (as long as you’re current on your mortgage).