Private Mortgage Insurance (PMI) is a type of insurance that helps protect lenders from financial losses in the event of a borrower defaulting on their mortgage loan. This type of insurance is usually required when a borrower makes a down payment of less than 20% of the purchase price of a home. In this article, we will cover the basics of private mortgage insurance, including how it works, how much it costs, and how to avoid paying for it.
What is Private Mortgage Insurance?
Private Mortgage Insurance (PMI) is an insurance policy that is taken out by a lender to protect themselves in case a borrower defaults on their mortgage loan. This type of insurance is typically required when a borrower makes a down payment of less than 20% of the purchase price of a home. PMI is designed to protect the lender’s investment and is not intended to protect the borrower.
How Does Private Mortgage Insurance Work?
When a borrower takes out a mortgage loan, the lender takes on a certain amount of risk. If the borrower defaults on their loan, the lender may be unable to recover the full amount of the loan. To protect themselves from this risk, lenders require borrowers to obtain private mortgage insurance. This insurance policy provides the lender with a financial cushion in case the borrower defaults on their loan.
If a borrower defaults on their mortgage loan, the lender will file a claim with the PMI provider. The PMI provider will then pay the lender a portion of the outstanding balance of the loan. The amount that the PMI provider pays depends on the terms of the insurance policy. Typically, the PMI provider will pay the lender up to 20% of the original loan amount.
How Much Does Private Mortgage Insurance Cost?
The cost of private mortgage insurance depends on several factors, including the size of the down payment, the credit score of the borrower, and the type of loan. The cost of PMI is usually between 0.3% and 1.5% of the original loan amount per year.
For example, if a borrower takes out a $200,000 mortgage loan with a down payment of 10%, they would be required to pay for PMI. Assuming a PMI rate of 1% per year, the borrower would pay $2,000 per year for PMI. This amount would be added to their monthly mortgage payment.
It is important to note that the cost of PMI is not tax-deductible. However, borrowers may be able to deduct the cost of PMI on their federal income taxes if they meet certain requirements. For example, if a borrower’s adjusted gross income is less than $100,000 per year, they may be able to deduct the cost of PMI on their taxes.
How to Avoid Paying for Private Mortgage Insurance
There are several ways to avoid paying for private mortgage insurance. One option is to make a down payment of at least 20% of the purchase price of the home. This will eliminate the need for PMI, as the borrower will have enough equity in the home to protect the lender’s investment.
Another option is to take out a second mortgage to cover the down payment. This is known as a piggyback loan or a second mortgage. In this scenario, the borrower takes out two loans – the first mortgage and a second mortgage to cover the down payment. The second mortgage typically has a higher interest rate than the first mortgage, but the overall cost may be less than the cost of PMI.
Finally, some lenders offer lender-paid mortgage insurance (LPMI). With LPMI, the lender pays for the cost of the PMI upfront, and the borrower pays a slightly higher interest rate on their mortgage loan.
