What is PMI and why do I need it?
PMI is an acronym for Private Mortgage Insurance. You will learn about this when you apply for a mortgage.
PMI is an insurance policy on your mortgage that
protects the mortgage company in case of default by the borrower. The
payment amount for the PMI depends on the size of the loan and the
amount of the down payment. The PMI payment is rolled into the monthly
mortgage payment. Once the mortgage company receives your mortgage
payment, they forward the PMI portion of your payment to the insurance
PMI is only required when the amount of the down payment on the loan is less than 20%.
Example: a $100,000 loan with a down payment of $10,000 equals a loan
total of $90,000. PMI would be required for this loan. If the same
$100,000 loan had a down payment of $20,000 to equal a loan total of
$80,000. PMI would not be required.
Having a large down payment may not be an option for many home
buyers. Allowing for smaller down payments gives the mortgage company
the ability to write more loans. PMI insurance covers the risk that the
loan company is taking by giving out loans with small down payments.
If you have PMI on a mortgage, you may be able to have it removed once the equity in your home is greater than 20% of the loan amount.
On that same $100,000 loan with the $10,000 down payment, at the time
of purchase, the current value of the home is $100,000. In the future,
when the value of the home is above $110,000 and the loan amount has
decreased with monthly payments to create a 20% equity, the borrower can
write the mortgage company and ask to have the PMI removed.
Before writing the request, I would recommend that a professional
appraisal be done on the home to verify your position and then forward a
copy of the appraisal along with your request to have the PMI removed.
The borrower will have to pay for the appraisal. Once the PMI has
been removed, the monthly savings will pay you back for the appraisal in
a matter of months. The future savings over the life of the loan is
well worth the cost. PMI insurance payments are not tax deductible.
An alternative to PMI would be for the borrower on
the same $100,000 loan with a $10,000 down payment to take out a second
mortgage for the other 10%. This second mortgage would have a higher
percentage rate of interest than the first mortgage. The combination of
the two mortgage payments may be less than a single mortgage payment
with PMI and interest on both of the loans would be tax deductible.