Private Mortgage Insurance – What You Should Know

Private Mortgage Insurance – What You Should Know

If you are not able to make at least 20% down payment on your home, then you’ll have to purchase a Private Mortgage Insurance policy. It is commonly referred to as PMI. It protects the mortgage lender if the borrower defaults on loan repayment. PMI is usually based on a percentage of your mortgage loan that you need to pay every month. Therefore, it varies with your credit risk and the amount of your home loan.

Types of Private Mortgage Insurance

Private Mortgage Insurance policies can be categorized into 2 types – (1) Borrower-paid PMI and (2) Lender-paid PMI. Each of the 2 types is discussed below.

1. Borrower-paid Private Mortgage Insurance: It is a type of Private Mortgage Insurance policy wherein the borrower pays the insurance premium. Generally, a mortgage borrower needs to purchase this policy when he/she is unable to afford 20% down payment on a home loan. It is also referred to as Borrower-paid Private Mortgage Insurance (BPMI) or Traditional Mortgage Insurance.

2. Lender-paid Private Mortgage Insurance: In Lender-paid PMI (LPMI), though the lender pays the premium cost of PMI, yet ultimately, the borrower has to bear the premium cost. Usually, lenders add the premium cost with the mortgage loan interest. Generally, a lender buys this insurance policy in case of high loan-to-value mortgage.

How to avoid Private Mortgage Insurance

You can avoid PMI even if you’re unable to make 20% down payment on your home. Here are some ways following which you can avoid purchasing a PMI policy.

Go for an 80-10-10 home loan: In this loan program, you’ll have to take out 2 loans along with paying 10% down payment on your home.

The first mortgage finances 80% of the sale price and the second mortgage finances the remaining 10%. It is also referred to as piggyback loan.

However, it may not be possible for you to take out a piggyback loan in present times. Lenders are not offering this loan due to credit crunch that started in 2007.

Pay more interest on your mortgage: You can avoid PMI by paying more interest on your mortgage loan. Most of the times, the lenders waive off PMI if the borrowers pays more interest on the home loan.

Borrow from your friends/family members: You can borrow the required amount from your friends or family members. It is advisable that you mention the terms and conditions of repayment in writing so as to avoid any misunderstanding in future.

When you purchase Private Mortgage Insurance, it is quite important that you cancel it once you’ve repaid 20% of your home loan so that you only have 80% loan on your home. However, it may take a much longer time as most of your initial payments go towards the interest; you cannot pay much towards your principle in the initial period of the loan term. Most lenders allow borrowers to cancel PMI after 2 years of on time payments.

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