You Need Personal Mortgage Insurance If Your Down-payment Was Less Than 20%
You found the perfect home. You qualified for a mortgage. But wait! Your lender wants you to pay an extra monthly surcharge for Personal Mortgage Insurance (PMI), also known as Private Mortgage Insurance, which is currently tax-deductible. What is PMI and do you have to have it with every mortgage?
PMI is insurance for the lender in case you default on your mortgage. Most lenders require you to take out this insurance if you are putting down less than 20% on your new home. As a practical example, suppose you took out a $300,000 home in 2007 and only put down $10,000. In 2008, the housing crisis hits and you find your house only has a fair market value of $180,000. You’ve suddenly lost $120,000 in equity! Some people would not want to take the hit and would stop making payments, go in to default and let the bank repossess the house. PMI is there to protect the lender from just such situations.
Now the good thing about PMI is that it allows borrowers who can’t come up with at least a 20% down payment to still be able to buy a house. Generally, when obtaining a mortgage that requires PMI, you must purchase one year’s worth of insurance which is held in an escrow account. This can be expensive.
A way to avoid PMI when you can’t put 20% down is to take a first mortgage for 80% and a second mortgage for 10%. You’ll pay a little more interest but won’t need PMI.
Over time, you hopefully will be able to build up equity either by the market value of your house appreciating and/or making monthly payments toward your mortgage. If you can convince the lender that you have attained at least 20% equity in your home, you will no longer be required to carry PMI. Any unpaid funds still remaining in your escrow account will be refunded.
Many people are unaware that they can cancel their PMI and they continue to pay needlessly for years and years. The lender may or may not notify you that you have sufficient equity in your house to cancel your PMI. It is up to you to keep a close eye on the value of your investment. Your lender may require you to have an appraisal to determine the market value of your house. Build your equity. You can stop making extra payments and maybe even get back some of your money.
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