Private mortgage insurance (commonly known as PMI) is a type of insurance that protects the lender if the borrower fails to repay his home loan. Most lenders require such a policy when the borrower makes a down payment of less than 20% of the property’s total value or sale price. The PMI premium is included in your monthly mortgage payments, but some schemes allow the borrower to pay all the premiums in one go.
Despite having a bad reputation in the market, as a product that favors lenders, private mortgage insurance is a good solution as it allows you to buy property with very low down payments. The insurance covers the risk of default and also protects the lender in case of unforeseen circumstances such as death of the borrower.
All you have to do is to make timely payments until you own at least 22% of your home. Once you have reached this limit, the insurance company has to cancel the PMI, but to qualify for this cancellation, you should not be a high risk borrower.
You can choose your mode of premium payment for private mortgage insurance, though you might not have a say in choosing the insurance company. You can pay the premiums as a lump sum amount, or as monthly or annual payments. The rate that you’ll have to pay could be anything from 1% to 6% of the shortfall in down payment, depending on your credit score and several other factors.
If you are not willing to go for a PMI, you can ask the lender to waive the insurance requirement. If he agrees, he will ask you to pay a higher interest rate on the loan. The lender can increase the rate by .75% to 1%, depending on your initial payment. This may however work to your advantage in some cases, as the interest that you pay will remain tax deductible. Although payments for PMI are also tax deductible currently, that rule is likely to change soon.
The best way of avoiding payment on private mortgage insurance is through making a down payment of more than 20%. Considering how expensive the insurance will turn out to be, it may be a better option to use your savings to fund the down payment. You may have to suffer some hardship to be able to do this, but it will be much cheaper in the long run.