Private mortgage insurance (PMI)

Definition

Private mortgage insurance (PMI) is a type of insurance that lenders require from homebuyers who are unable to make a down payment of at least 20% of the home's purchase price. This insurance protects the lender against the risk of default on the loan, allowing buyers with lower down payments to qualify for a mortgage. PMI is typically added to the monthly mortgage payment, increasing the overall cost of homeownership.

5 Must Know Facts For Your Next Test

1. PMI can cost between 0.3% and 1.5% of the original loan amount per year, depending on various factors such as loan type and credit score.
2. Homebuyers can often cancel PMI once they reach 20% equity in their home, which can lead to significant savings over time.
3. PMI is not a permanent requirement; it typically lasts until the borrower has paid down enough of the loan or the property's value has appreciated significantly.
4. Some lenders offer lender-paid mortgage insurance (LPMI), where the cost is incorporated into the interest rate instead of monthly payments, but this can result in higher overall borrowing costs.
5. It's important for potential homebuyers to understand PMI, as it impacts monthly mortgage payments and overall affordability when purchasing a home.

Review Questions

• How does private mortgage insurance (PMI) affect the affordability of homeownership for buyers with low down payments?
  • PMI increases the overall monthly costs for homebuyers who make a down payment of less than 20%, which can impact their budget and affordability. While it allows these buyers to secure a mortgage, the added expense can strain finances, making it essential for potential homeowners to consider both PMI costs and their long-term financial plans when deciding on purchasing a home.
• Discuss the circumstances under which a homebuyer can cancel their private mortgage insurance (PMI) and what steps they must take.
  • A homebuyer can cancel their PMI when they reach 20% equity in their property, either through paying down the principal or if the property value appreciates. To initiate cancellation, borrowers typically need to request an appraisal or provide documentation proving their current equity position. It's crucial for homeowners to monitor their equity status and stay informed about how to remove PMI, as doing so can lead to significant savings on monthly payments.
• Evaluate how different types of mortgage insurance, including lender-paid mortgage insurance (LPMI) versus borrower-paid private mortgage insurance (PMI), influence long-term financial outcomes for homeowners.
  • The choice between lender-paid mortgage insurance (LPMI) and borrower-paid PMI significantly affects long-term financial outcomes for homeowners. LPMI incorporates insurance costs into a higher interest rate, which can increase total borrowing costs over time. Conversely, borrower-paid PMI leads to lower initial monthly payments that may be cancellable once sufficient equity is gained. Homebuyers should assess their individual situations and long-term plans to choose an option that aligns with their financial goals.

Related terms

Down Payment:

The initial amount of money a buyer pays towards the purchase of a home, typically expressed as a percentage of the home's total price.

Mortgage: A loan specifically used to purchase real estate, where the property serves as collateral for the lender.

Equity:

The difference between the market value of a property and the amount owed on the mortgage, representing the owner's financial interest in the property.