Before the current mortgage crisis, lenders routinely allowed borrowers to purchase a home with less than a 20 percent down payment. These borrowers had to agree to purchase mortgage insurance, sometimes referred to as private mortgage or PMI. Unlike most types of insurance, these policies do not pay homeowners in the event of a loss; rather, they pay the lender if the borrower defaults on his or her loan.
PMI Rationale
No home owner starts out intending to default on a loan, but if you run into trouble, default seems like a much more viable option if you don’t have much equity built up in the property.
Lenders who were willing to take the risk of loaning money to people who couldn’t come up with the traditional 20 percent down payment wanted some protection for themselves in the event that the borrower simply walked away from the property without paying. PMI seemed a fair solution.
Cost of Mortgage Insurance
The insurance usually costs between one-half to one percent of the total loan each year. If you divide that amount by the twelve months in the year, you will get the amount added to your monthly payment. Depending on the amounts involved, most borrowers find that this additional insurance increases their monthly payments between $35 and $75. Payments made to insure a mortgage are not tax deductible.
By law, you no longer have to pay for this insurance once you have built equity in your home of 22 percent or more of the principal. Many lenders will let you off the hook if your equity meets or exceeds 20 percent, or 1/5, of the principal of the home.
A Fading Practice?
The last several years have seen the United States fall into a mortgage crisis with an unprecedented amount of foreclosures and defaults. Given the current economic client, many banks simply won’t work with a buyer who can’t raise a 20 percent down payment on his or her home.
If the borrower is able to produce the 20 percent down payment, of course, there is no reason for him or her to purchase mortgage insurance.
