Private Mortgage Insurance

Q: I’ve saved $20,000 to put toward the purchase of a home. The home I’m interested in buying, however, costs $200,000 and I’ve been told that unless I can come up with a larger down payment, I’ll need to take out private mortgage insurance. What is this and how does it work?

A: As a general rule, lenders require those who take out a mortgage on a home with a down payment of less than 20 percent of the home’s appraised value or sale price to obtain private mortgage insurance.

This protects the lender in the event that you default on your loan by ensuring that the outstanding balance will be paid off.

The cost of private mortgage insurance tends to vary depending on the size of your down payment, the type of mortgage and the amount of coverage your lender requires. In general, it’s about one-half of one percent of the value of the loan, according to the Mortgage Bankers Association of America.

If you were to take out a $180,000 mortgage, it would cost around $180,000 multiplied by .005, or $900 a year. Divided by 12, this would add $75 a month to the cost of your mortgage.

The advantage of private mortgage insurance is that it enables you to purchase a home with a lower down payment than would otherwise be possible. It also provides lenders the security of knowing the money they loan is not at risk.

Most lenders will require you to keep private mortgage insurance until you achieve 20 percent equity in your home. It is up to you to keep track of when you reach this point and to notify the lender to discontinue the insurance. The lender could require a new appraisal that you may have to pay for as well.

In some cases, if you fall into a high-risk category due to factors such as poor credit history or a high debt-to-income ratio, a lender may require you to keep the insurance until you achieve up to 50 percent equity in your home.

It may be possible to finance the private mortgage insurance if you are willing to accept a higher interest rate on your mortgage, instead of paying the premium as a separate monthly fee. The advantage of this option is that mortgage interest is deductible, whereas mortgage insurance premiums are not.

For more information about private mortgage insurance, including how to cancel a policy, visit the web site for the Mortgage Insurance Companies of America.