What is PMI and what should you do about it?

If you are thinking about buying a home, one of the terms that you may have heard discussed is PMI, or Private Mortgage Insurance. Sometimes it may also be referred to as LMI, or Lender’s Mortgage Insurance.

So what is PMI?

PMI is insurance paid for by you that will cover any losses sustained by the bank if you fail to repay your loan.

The key point here is that it is insurance that you have to pay for but from which you don’t really receive any benefit.  It only benefits your lender as it protects them if you default on your loan.

Normally PMI is based on a percentage of the original loan amount and may vary from about .3% to 1.15% The size of your down payment can affect the percentage you pay as well.

Why pay PMI?

The idea behind PMI is that it covers the lender from any losses if you don’t repay. But your home you are buying is also providing collateral to cover the loan. If you don’t make your payments, the bank will eventually foreclose and then sell your home to cover the remaining balance on your loan.

So why do you need PMI if your home is providing collateral for the loan?

If you buy a $200,000 loan and put $75,000 down so you are only borrowing $125,000, you will not need to pay PMI. The bank is almost certain to be able to sell your $200,000 home for more than the $125,000 you owe. Their risk is very low.

But what if on the other hand, you only had a $10,000 down payment, so your loan was for $190,000? What if there is a downturn in home prices in your area like we saw in 2008 and your home value falls from $200,000 to $170,000? Now the bank has the potential to lose money if you don’t make your payments.

So, where is the point where you don’t have to worry about PMI? Generally speaking, if you make a down payment of at least 20% of your home’s current appraised value, you won’t have to pay PMI.

How to get rid of PMI?

If you have PMI currently on your mortgage, it may be possible to get rid of it.

The key is you need to pay your loan down sufficiently that your remaining balance is less than 78% of your mortgage. So if you had a mortgage on that $200,000 home we talked about earlier you would be eligible to have PMI removed once your remaining balance was $156,000 or less.

While you are eligible to have PMI removed, there is no guarantee your mortgage company will do it automatically. You may need to contact your mortgage company and request that it be removed. Be aware that in some cases your mortgage company may require you to get a new appraisal to show that you really do have enough equity.

If you live in an area where property values have done well and you think your home is now worth significantly more than it was when you purchased it, then this can work in your favor, since you won’t need to have your mortgage paid down quite as much.

Be aware that the rules for FHA loans changed last year. On some FHA loans, you are no longer allowed to remove PMI regardless of your balance. For these loans you may need to refinance to get rid of the PMI.

What to do about PMI?

PMI only protects your lender. You are essentially paying to benefit someone else. Kind of like offering to pay your neighbor’s car insurance. Your neighbor may think you are awesome, but it doesn’t help your finances any. You’d be much better off if that money you are spending on PMI were going to pay down your principal.

The best answer:

The best solution is to save until you can pay at least 20% or more down on your home. Or if you you don’t have 20% saved, look for a less expensive home that you can pay at least 20% down on. If you are able to make a down payment of at least 20% or more, you’ll never have to worry about paying down PMI.

If you already have PMI:

If it’s too late and you already have PMI, work as quickly as you can to get your loan paid down to where you can have PMI removed.

Once you believe you have paid the mortgage down enough to reach that 78% level, follow up with your lender and make sure it is removed.

If you don’t make a large down payment, you don’t have any choice whether to pay PMI. But just remember PMI benefits the lender not you. Every month you pay PMI, you are throwing away dollars you could be using to get your mortgage paid off.

What experience have you had with PMI? Tell us your story.

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