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Private Mortgage Insurance (PMI) is insurance the buyer purchases to cover the loan for the lender if the property goes into foreclosure due to nonpayment. If you want to buy a house and you do not have the 20% of the value of the home for a down payment you can still qualify for the purchase. This is where PMI comes into play.

The lender benefits from the buyer’s purchase of the insurance. The lender is protected from default loss. The buyer benefits because he/she may qualify for a larger home or qualify to purchase a home sooner. If the buyer has to wait until he/she has 20% of the home’s value for a down payment, it will be sometimes years before the buyer will have enough to buy a house. A website PrivateMI.com says that PMI has helped Americans buy homes upwards of 25 million buyers. Here’s an example of how a buyer can use PMI for purchasing a home: A home sells for $300,000. If you have to put 20% down to qualify for the note, you will have to have $60,000 in cash. On the other hand, if you put 3% down you will have to have $9,000. A lot of buyers can save up $9,000, but there are not a lot who can save $60,000.

PMI then is offered as an alternative to the buyer who does not have the 20% down. The lender as a rule will choose the PMI provider and bill the homeowner for the premium. Government backed loans such as Veteran’s Administration (VA) loans and Federal Housing Authority (FHA) loans do not have PMI but they have other insurance for the lender. Not only that, the federal government backs the loan for the lender in the event of default.
The buyer who does not put down 20% is essentially taking out a larger mortgage for the home. In the example above on a $300,000 house: $300,000 – $9,999 = $291,000. The buyer will finance $291,000 of the value of the home. The interest will be more over the life of the loan than a buyer who is financing as follows: $300,000 – 60,000 = $240,000. The buyer placing down 20% will finance $240,000. According to the site Bankrate.com the cost of PMI is around .5% of the loan. As to what is reported by GoodMortgage.com a home buyer with a 30 year note at 5% for the $291,000 will pay around $238 for PMI premiums. Usually the PMI premiums are paid on a monthly basis as part of the monthly mortgage payment. Some lenders allow an upfront payment of the premium along with the other costs at closing of the property.

Bankrate.com lists two ways you can avoid paying PMI. One way is to ask the lender to waive the PMI in exchange for a higher rate of interest on the note. The rate of interest can be as much as ¾% to 1% higher. Another way is to take out a second loan. There are 80/20 loans and 80/10/10 loans. An 80/10/10 is 10% down on the house, a 10% loan on the house, and an 80% loan on the house. It sounds like it would cost more to do 80/10/10, but BankRate.com says that the total monthly payment for two loans can still be less that for the one loan with PMI. A buyer who takes the higher interest rate may be ahead because mortgage interest rate is deductible on federal income tax and PMI is not.

If you are a buyer who could not avoid PMI by any of the above means, then you may be able to cancel the PMI when certain conditions are met. When you have 20% paid into the equity of the home, you can apply to the lender to drop PMI. Motley Fool says that this applies to the appraised value of the home and not the amount of the loan. If you are in a neighborhood where you have seen houses increase in value, you might want to make the small investment in an appraisal. You can submit that new appraisal to your lender and ask for PMI to be dropped. If you bought a home ‘as is’ or a ‘fixer upper’, then you may apply for an appraisal after you have completed the remodeling and you believe that your home will appraise for a higher value. According to the PrivateMI.com site most borrowers can cancel their PMI within five years. This applies to 90% of the home owners who carry PMI.