Buying a house is a process involving many parties and documents, especially when there’s a mortgage involved. Most home purchases are made with a mortgage rather than buying the property outright, and the average down payment on these mortgages is 14.71% of the total sale price. This means that many homeowners pay for private mortgage insurance as part of their monthly loan payments.
This form of insurance is different from homeowner insurance, which serves to protect your home and compensate you for damage to your property. Private mortgage insurance is a form of protection for the financing institution that services your mortgage. The sooner you can remove this insurance from the equation, the more money you’ll save over the life of your mortgage — but there’s more to the story. Here’s what to know about private mortgage insurance before you apply for a home loan.
How Private Mortgage Insurance Functions
In some ways, private mortgage insurance works like gap insurance when you’re financing a vehicle. In the event of an accident that totals your car, your auto insurance can cover the costs of the damage, up to the full value of the car. When you’ve been making payments on a new vehicle for a couple of years, you may owe more on the loan than the car is actually worth — new vehicles can depreciate quickly. This means you could still owe money on the loan even if you receive a payout for the car’s full value after insurance pays you for a covered claim. Gap insurance increases your monthly premium in exchange for protecting you against the difference in value, making sure that you won’t be stuck making payments on a car you no longer own.
Private mortgage insurance provides a similar kind of protection, but for the lender’s benefit. If you’re unable to make payments on your home and end up defaulting on the mortgage, your home may go into foreclosure. Depending on how much the foreclosed home can be sold for, there may not be enough money from the sale to repay the lender. Private mortgage insurance will fill in that gap and make sure that your lender is protected from that loss in value.
Why Many Homeowners Have Private Mortgage Insurance
Considering that this insurance exists to protect lenders and the home buyer must pay for it, why do so many people have private mortgage insurance? Most lenders do not require private mortgage insurance if the buyer makes a down payment on the home of 20% or more. This amount of equity is enough for lenders to feel confident that a foreclosure proceeding should still result in the full mortgage being paid off.
On the other hand, mortgages with down payments of less than 20% of the home’s total value generally require this insurance to secure financing in the first place, according to the Consumer Financial Protection Board. For many Americans, the dream of owning a home is worth the added cost of paying private mortgage insurance.
How to Avoid Private Mortgage Insurance
Even if you find it preferable to have a home and pay private mortgage insurance instead of renting, it’s still an extra expense that reduces your usable income and doesn’t provide any added protections for your family. Therefore, you may want to try to remove it from the equation as soon as possible.
The easiest way to avoid private mortgage insurance is to make a down payment of 20% or more when purchasing a home. This amount prevents the loan from exceeding the 80% threshold, meaning the lender will not require private mortgage insurance from you. If you can’t make a full down payment in that amount, Investopedia relates a clever way to get around it: split your mortgage between two lenders. Private mortgage insurance is based on the mortgage’s total amount compared to the home value, so it does not factor in a second mortgage. As long as neither mortgage is above 80% of the home’s value, you may be able to avoid private mortgage insurance. However, it may be difficult to secure two mortgages at the same time, depending on your finances.
If you already have a mortgage with private mortgage insurance built in, then there are still two ways to remove it. First, you can refinance your home. Refinancing your home replaces your existing mortgage, meaning that you can make any additional payments needed and take advantage of changes in the real estate market to secure a new mortgage that’s 80% or less of the total home value. Second, you can wait until your current mortgage’s principal is 80% or less of the total home value and petition your lender to remove the requirement for private mortgage insurance. If the lender accepts, then you may be able to avoid making any further premium payments without having to pay closing costs and fees associated with refinancing your home.
Resource Links
“Average Down Payment on a House” via Bankrate
“What Is Private Mortgage Insurance?” via the Consumer Financial Protection Bureau
“How to Avoid Paying Private Mortgage Insurance (PMI)” via Investopedia