Do I Need Private Mortgage Insurance?

Many lenders will require you to pay private mortgage insurance (PMI) as a part of your home mortgage loan. Lenders want to protect themselves in the event that the borrower defaults. Unless you can put down at least 20 percent of the value of the home as a down payment, you may be required to pay PMI.

While many home buyers object to having to pay for mortgage insurance, PMI actually helps buyers get more home for their money. Without PMI, lenders would require much larger down payments. But since PMI covers the lender against default, they are willing to accept as little as 5 percent down on some loans.

The annual cost of PMI insurance is typically .5% of the total amount of the loan, but is paid as part of your monthly mortgage payments. To calculate PMI payments on a loan amount of $200,000, multiply by .005 to get your annual PMI amount, which in this case would be $1,000. Divide that by 12 to determine how much you would pay each month; monthly payments in this example would be $83.33.

Here's another example of how PMI can help you increase your buying power. Without PMI, a $20,000 down payment would limit you to homes costing $100,000 or less. But with PMI, you could apply that same $20,000 as a 5 percent down payment on a $400,000 home. PMI gives you more options, and allows you to get more home for your money.

Thanks to the Homeowner’s Protection Act of 1999, you do not have to pay for PMI forever. Once you have paid off 20 percent of your loan balance, you can request that your PMI be terminated. You must submit your request in writing to your lender. The lender will then look at your payment history to determine if PMI should be cancelled. If your payment history has been good -- meaning that you have not been 30 days late with your mortgage payment within a year of your request or 60 days late within two years your request -- the lender will likely grant your request, provided the value of the property has not declined and there is no second mortgage or home equity loan.

When the balance reaches 78 percent (77 percent for high-risk loans) PMI is automatically terminated. If you are behind on your payments at the point where the loan is scheduled to be paid to 78 percent, the lender will wait until you reach that percentage before they terminate your PMI.

You can actually avoid paying PMI completely by piggybacking a second mortgage loan onto your first one. In piggybacking, you take one loan to cover 80 percent of the home and a second loan to cover the other 20 percent, less your down payment. Therefore, if you put up a 10 percent down payment, your financing would be 80-10-10, with the second and third numbers representing the second loan and the down payment. Some lenders do not offer this option, while some who do may charge a higher interest rate for the second loan. Compare that rate with the PMI rate before deciding whether or not piggybacking is for you.

Read "Reducing Your Monthly Mortgage Loan Payments" and "Choosing Rates vs. Points in a Mortgage Loan."