Pros and Cons of Private Mortgage Insurance
How to Save Money by Avoiding PMI and by Cancelling PMI On Time
Jul 7, 2009
Studies show that Americans are saving much less and spending a lot more than what their parents did. This spending habit coupled with the fact that home prices are going up at a rate which is much higher than the earning power of Americans makes it very difficult to save a large down payment for buying a home. However experience tells us that the more stake a person has on his home, less is the chance for default. Lenders typically require a 20% down payment to ensure that the borrower would not default on his loan.
Private Mortgage Insurance (PMI) was introduced to get around this problem. PMI protects the lender against defaults on the loan. On the other hand it also enables the borrowers with less than 20% down payment to purchase a home. Although it is the lender who is protected against the default, it is the borrower who pays the insurance premium.
PMI is only required for loans where the loan-to-value ratio is 80% or more. Once the principal is reduced to 80% of the value of the home, by virtue of a home value appreciation or the principal being paid down or both, PMI is no longer required.
Home Owner's Protection Act (HPA) of 1998
- Before 1998 lenders often canceled PMI payments but only on a specific request from the borrower. Borrowers who were unaware of the fact that PMI can be canceled after the 20% equity is reached, often continued paying for mortgage insurance long after the equity requirements were met.
- Homeowner's Protection Act (HPA) of 1998 made it the responsibility of lenders to cancel the mortgage insurance payments after the principal is 78% of the loan value. Lenders are also required to provide certain disclosures concerning PMI at closing, like how many years and months it will take for them to reach the 80 percent level, for loans given on or after July 29, 1999.
- In order to cancel the insurance premium the borrower should have a good payment history and should not have defaulted on the loan.
- Lenders can also continue the mortgage insurance on loans which are categorised as high risk.
- Borrowers can request for cancellation of PMI even before the principal is paid down to 78% of the loan value if they feel that their home has appreciated in value. The borrower will have to pay for a second appraisal of the home and if it has appreciated beyond the 20% equity value, the mortgage insurance can be canceled.
How to avoid Private Mortgage Insurance?
- The easiest way to avoid Private Mortgage Insurance is by putting down a 20% down payment but most borrowers cannot afford to do so.
- A piggy-back loan or a second mortgage on the property is another option. This was popular before 2007 because the interest payments on the second loan were tax deductible but the mortgage insurance payments were not. Now that both are tax deductible, borrowers often end up paying more on the second loan payments than what they would have paid for Private Mortgage Insurance.
- 80/10/10 and 80/15/5 are two popular variations of piggy-back loans where the borrower puts down 10% or 5% as down payment and the rest of the down payment is financed through a second mortgage.
- Borrowers should carefully examine the closing costs and interest payments on the second loan to see whether taking a second mortgage is better suited to them than paying for mortgage insurance.
Private Mortgage Insurance is a necessary evil. While it is better to avoid Private Mortgage Insurance altogether and save hundreds of dollars on insurance premium, it also enables a lot of people to achieve their dream of owning a home much earlier than waiting for years to save on a 20% down payment.
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