PMI, or private mortgage insurance, is a necessity most times. If your down payment is less than 20% of the purchase price of the home, then you’ll need to pay for this additional insurance in order to secure a loan for the home. This policy protects the lender if the borrower cannot pay the loan installments. This way, the lender knows they will not lose money in the event of default.
Private mortgage insurance is also required if you refinance your home when it has accrued to less than 20% equity.
Here are a few other key points to remember about PMI.
The fees involved with private mortgage insurance can range based on a few factors, including the actual size of the down payment and your credit score. You can expect the cost of the insurance to be somewhere between 0.3% and 1.5% of the loan amount per year. Homebuyers can pay PMI premiums either monthly or as a large payment up front, though some policies may require the borrower to pay installments versus a lump sum.
The lender will automatically cancel your PMI once the loan drops to 78% of the home’s value. For this reason, you’ll want to keep track of your payments to see how close you are to paying off your loan. When you’ve paid your loan down to 80% of the home’s original value, you may ask your lender to discontinue the insurance premium payments.
This ratio is the amount of mortgage debt as a percentage based on how much the home is worth. It’s calculated by the following formula:
Amount owed on the mortgage/Appraised value
If a home is worth $100,000 and the buyer owes $80,000 on the home, the loan-to-value ratio is 80%. This means the borrower can request the lender cancel the insurance.
If you secure an FHA loan, they require the payment of PMI premiums for the entire life of the loan. You can’t cancel these insurance payments, but you can refinance the loan in order to get rid of the insurance. This means that you will no longer have an FHA loan.
Private mortgage insurance can be confusing, but, as a first-time homebuyer with little capital, the fees may be worth it when you’re able to secure your first home.
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