Private mortgage insurance is required for home buyers who do not put up at least 20 percent of the home's value as a down payment when they take out a mortgage. This insurance protects the lender against the possibility that the individual will default on the mortgage. The borrower pays for private mortgage insurance even though he does not gain any additional protection from it.
How Much is Private Mortgage Insurance?
Private mortgage insurance generally costs between 0.5 percent and 1 percent of the cost of the loan per year. This cost is added to the monthly cost of your mortgage. For example, if your private mortgage insurance cost 0.5 percent and your mortgage was $150,000, your annual cost would be $750, or $62.50 each month. Unlike the interest rate on the loan, private mortgage insurance is based on the size of the loan rather than the individual's credit risk.
When Can You Stop Paying Private Mortgage Insurance?
Private mortgage insurance is required as long as the amount you owe on your mortgage is more than 80 percent of the value of your home. You can notify your bank when you reach the 80 percent threshold. Federal regulations mandate that the bank must cease charging a borrower for private mortgage insurance once she owes less than 78 percent of the home's value. This is based on the value of the home when you took out the mortgage.
Ways to Prove Home Value
You can stop paying private mortgage insurance early if you can prove that your mortgage is now less than 80 percent of your home. Even if you have not paid down your mortgage enough to cross the threshold based on your home's original value, if you have made improvements to your home or the prices of homes have risen in your area, you can have your home professionally appraised. Based on this appraisal, if the amount remaining on your mortgage is less than 80 percent of the home's value, you can request that the private mortgage insurance be canceled.
Ways to Avoid Private Mortgage Insurance
The simplest way to not have to pay private mortgage insurance is to make a down payment of 20 percent or greater. However, if this is not possible you can consider paying a higher interest rate or getting a second mortgage. Some banks will allow you to pay a higher interest rate, usually 0.75 percent or 1 percent higher than you would have paid otherwise, to avoid mortgage insurance. You can also consider an 80-10-10 loan, which involves you making a 10 percent down payment, a first mortgage for 80 percent of the price and a second mortgage for 10 percent of the price.
Purpose of Private Mortage Insurance
Conventional mortgages generally require 20 percent down payments on the home. This down payment ensures that the bank will be able to recoup its investment in case the home buyer defaults. Private mortgage insurance benefits both the borrower and the lender. It protects the bank in case the borrower defaults and it also allows people to buy homes earlier than they otherwise would because they do not have to make as large of a down payment.