Mortgage Insurance

Mortgage insurance - also called Lender’s Mortgage Insurance (LMI) or Private Mortgage Insurance (PMI) - is a policy that protects the lender from financial loss if the mortgagee (you) defaults on your home loan. So why is this important to know about a consumer? Because most mortgage lenders will require you to pay for the cost of private mortgage insurance. Read on to learn the essentials about lender’s mortgage insurance and how you can save money.

Who Has to Pay Mortgage Insurance

The rules vary from lender-to-lender and mortgage-to-mortgage, but the typical rule of thumb is that if your down payment is less than 20 percent of the value of the home, you’ll have to buy private mortgage insurance.

How Long Do I Pay Mortgage Insurance

Note: that’s 20 percent of the value of the home, not 20 percent of the mortgage itself. This is important because mortgage lenders will usually require you to continue paying premiums on private mortgage insurance until you accrue 20 percent equity in your home. So, if you make substantial improvements on your home, the real estate market soars or something else changes in your community to cause the value of your home to rise, you may end up paying PMI for a longer period.

How Much Does Mortgage Insurance Cost?

That depends. The premiums on your mortgage insurance are calculated by comparing the amount of your loan to the value of your home (loan-to-value ratio). The higher the ratio, the higher premiums. Furthermore, some mortgage lenders charge an additional upfront fee that goes towards your private mortgage insurance premiums. Private mortgage insurance premiums usually hove around .90 percent for loan-to-value ratios of 95 to 97 percent, .78 percent for loan-to-value-ratios of 90 to 95 percent and .52 percent for loan-to-value ratios of 85 to 90 percent. So, let’s say you’re taking out a $90,000 mortgage on a home valued at $100,000. Your loan-to-value ratio is about 90 percent and your PMI premiums will be around .78 percent of the loan, or $58.50 a month.

How Can I Avoid Private Mortgage Insurance?>

To avoid paying PMI costs, you can simply make a down payment of at least 20 percent of your home’s value. Alternately, you can get what is called a “piggyback loan.” For example, you could split the aforementioned $90,000 mortgage into two separate mortgages - one mortgage for 80 percent of the home value ($80,000) and another mortgage for the remaining 10 percent, or $10,000. Then, you could pay $10,000 down. (Hence, these arrangements are often called 80-10-10 mortgage loans.) You will pay a higher interest rate on the second mortgage, but the cost is often less than what you would pay for PMI premiums, especially since mortgage insurance payments are tax deductible. In essence, you’re borrowing $10,000 in order to put a larger down payment on your home.

Conclusion

Private mortgage insurance is required to protect mortgage lenders from financial loss in case you default on your home and the home cannot be sold to recoup their losses. Because lenders who put less than 20 percent down on their home are viewed as riskier bets, it’s common practice to require mortgagees with less than 20 percent equity to buy PMI. As such, it’s worthwhile to explore your options for ways to avoid PMI, either by saving up more money or getting a piggyback loan.