Mortgage insurance can add an extra bill to pay every month, but unlike homeowner’s insurance, it doesn’t protect you — it protects your lender. Learn about why it’s often required and how you may be able to avoid it.
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Private mortgage insurance, or PMI, protects the lender in case of default. Lenders usually require you to pay it when your loan-to-value ratio is more than 80%. To avoid this, your down payment has to be at least 20%, or one-fifth, of the home’s purchase price. For example, if the price of the home is $200,000, a 20% down payment would be $40,000.
Purchase Price / 5 = 20% Down Payment Example: $200,000 / 5 = $40,000
PMI can cost as much as 1% of the total loan amount per year. Continuing our example above, say the down payment is $10,000 (5% of the purchase price). The loan amount would then be $190,000. With a 1% PMI fee, that’s an extra $1,900 to pay every year. This increases each monthly mortgage payment by $158.33!
(Loan Amount * Annual PMI Fee) / 12 Months = Extra Monthly Expense Example: ($190,000 * 1%) / 12 = $158.33
Your lender might also agree to pay the PMI for you in exchange for raising your interest rate.
An extra expenseIt’s best to avoid mortgage insurance, if you can. If you pay for it yourself, the extra expense does nothing to increase your equity. If your lender pays for the insurance, you will end up paying even more in increased interest in the long run.
If you must get PMI when you close on your home, the good news is that you may be able to cancel it once you have paid down your mortgage enough that your loan-to-value ratio drops below 80%.