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Mortgage Insurance & Premiums Explained

For most home mortgage lenders, there is a benchmark for equity required for a normal mortgage loan.  They want to see 20% equity in ownership to make a regular loan without other protections.  The theory is that a borrower will be more likely to avoid default the higher the equity in the home.  If the buyer cannot make a 20% down payment, there is mortgage insurance to protect the lender.  This is PMI, or Private Mortgage Insurance.  This insurance coverage pays the lender if a borrower defaults and there isn’t enough equity to sell the home and pay off the mortgage and costs of sale.

When a buyer, and there are a lot of them, cannot make a 20% down payment, there are costs added to their loan for mortgage insurance.  There can be an upfront cost, as well as monthly premiums (MIP: Mortgage Insurance Premium) that are added to the monthly payment.  Rates vary for this coverage, usually based on a multiplier applied to the mortgage amount.  This multiplier also varies by the percentage of the down payment.  In other words, a 5% down payment would have a higher multiplier than a 10% down payment, resulting in a higher premium to offset the increased risk to the lender.

How Long Do Mortgage Insurance Premiums Continue?

By law, the borrower has the right to request cancellation of the coverage and premiums when equity in the property reaches or exceeds 20%.  Normally, this happens when enough has been paid in normal payments, but can also be proven to the lender with an appraisal that shows the value has appreciated as well.   The borrower would have to pay for that appraisal, and has no guarantee that it will come in high enough.  The more common method is in a refinance, when an appraisal is a part of the process, and a lower interest rate might be available as well.

Why & How to Avoid Mortgage Insurance Costs

  • Why to Avoid – The obvious reason to try and avoid PMI is to do away with the additional monthly payment for the premium.  This can be quite a bit of money over the life of the loan, as common examples show an addition based on 0.5% per month to the payment.  This would be around $50/month on a $100,000 loan, and go higher proportionally with larger loans.
  • How to Avoid – A borrower can avoid PMI with less than 20% down through a second mortgage at the time of origination.  A common method s the 80-10-10 loan setup.  The first mortgage is for 80%, which avoids PMI, and is possible with only 10% down payment by taking a second mortgage of 10%.

PMI isn’t an evil plot against homeowners, as many could not become owners without this insurance product.  Lenders wouldn’t issue mortgages if their risk couldn’t be lowered with PMI.  But knowing how to avoid it, or when it can be canceled, can reduce the long term costs of borrowing.

Jim Kimmons – HomeLoans.org Expert Jim is a New Mexico real estate broker who has held real estate brokerage licenses in Texas and Colorado during his 15 years of real estate practice. He is the Real Estate Business Guide writer for the New York Times website at About.com where he takes a pro-consumer stance in writing business articles for real estate agents, mortgage brokers, and real estate investors.

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