Private mortgage insurance has become a common way of offsetting the risk for mortgage lenders when buyers have a small down payment. If your down payment on a property is less than 20% of its appraised value (or sale price, in some cases), your lender will require that you obtain private mortgage insurance. This insurance is protection for the lender against a default on the loan.
How Much and Who Pays?
The borrower is responsible for paying private mortgage insurance, and the insurance payments are added to your mortgage loan total and your monthly mortgage payments.
The cost will vary depending on the size of your down-payment and the size of the loan. Typically the annual cost is about 0.5% of the total loan amount. For example, on a $100,000 property with a $10,000 down-payment, your loan total is $90,000 and your private mortgage insurance would be $450 a year divided into monthly payments.
When Can You Cancel the Insurance?
Typically, you can cancel private mortgage insurance once you have 20% equity in the house. This means that you must reach a point where you have paid 20% of the principal of the loan. In some high-risk situations, such as bad credit loans or reduced documentation loans, some lenders may require that the borrower build up to 50% equity (the maximum amount allowable by law) before allowing them to cancel the insurance.
Under the Homeowner's Protection Act of 1998, lenders are required by law to tell borrowers how long it will take them to obtain 20% equity in the property. Additionally, lenders must cancel private mortgage insurance automatically once the borrower has 22% equity (unless it is a higher-risk loan which requires more than 20% equity). For the above loan example, you could cancel the insurance once your principal balance hits $80,000, and it would automatically be cancelled at $78,000.
Note, however, that this law does not apply if your purchased, built, or refinanced your current home before July 29, 1999. If you are in this situation, you must contact your lender to cancel the insurance because it will not be done automatically once your equity reaches 22%.
Canceling PMI may require that your property undergo appraisal, to ensure that you have 20% equity according to its current value.
Avoid Private Mortgage Insurance with a Piggy-back Loan
Also called an "80-10-10" loan, this involves two separate loans which close simultaneously, and a 10% down-payment. Depending on your situation, it can be less expensive than paying private mortgage insurance.
The first mortgage is for 80% of the property's sale price, and the second mortgage is for 10% of the sale price, which requires the borrower to come up with 10% as a down-payment. The second mortgage will usually have a higher interest rate, but because it applies to just 10% of the loan total, the combined monthly payments are usually lower than payments for one mortgage plus insurance. Additionally, mortgage interest is tax deductible, while the insurance is not, providing a further advantage.
For example: on a $100,000 property, with a single mortgage for $90,000 at 7.5% you'd pay $629 a month, plus insurance of $37.50 a month, for a total of $666.50.
With a piggy-back loan, you pay a $10,000 down-payment. Your first mortgage is for $80,000 at 7.5%, and your second is for $10,000 at 9.5%. Your monthly payments would be $559 and $84 for a total of $643, saving you $23.50 a month.