If you purchase property and your down payment is less than 20% of the appraised value, the lender will require you to buy a private mortgage insurance, known as PMI.
This is in order to protect the loan and make sure that in case of mortgage default, the insurance will pay the balance owed by the borrower.
PMI charges vary depending on the size of the down payment and the loan, but they typically amount to about one-half of 1 percent of the loan, according to the Mortgage Bankers Association of America. Mortgage insurance premiums are not tax deductible.
Let's say you put down 3.5 percent or $3,500 on a $100,000 house. The lender multiplies the 96.5 percent loan, or $96,500, by .005. The result is an annual PMI of $480, which is divided into monthly payments of $40.00 per month
Once you make payments and reach the 20% equity, the bank will waive the PMI.
Most home buyers need PMI because 20 percent of the sale price on a home is a lot of money; for instance, that's $20,000 on a $100,000 home. Home buyers must maintain the PMI premiums until they cross that one-fifth-of-principal threshold, a process that can take years in longer-term mortgages.
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