Private Mortgage Insurance
Generally known as PMI, private mortgage insurance takes effect whenever you have a mortgage loan in which you owe more than a certain percentage of the home’s total value. This threshold is normally set at 80%, so if your down payment is less than 20% you’ll most likely have to add mortgage insurance onto your monthly payment. The amount you owe compared to your home’s value is called the DTV, or deb-to-value, ratio. This type of insurance exists because lenders realize that leveraging a loan with such a high debt-to-value ratio is an increased risk. If the loan went into default for any reason, the costs to the lending company of foreclosing on a home and turning it around by selling or auctioning it off at a discount may not offset the amount they paid you for it. It’s true that while you owe the bank money, the house is technically still theirs because they paid for it, even though the deed is listed in your name!
The PMI Threshold
Once you reach that magic threshold amount, your mortgage insurance is discontinued. This can happen in a few different ways: you can make extra payments to pay down the difference quicker, or you can just make your regular payments for several years until 20% of the loan has been paid down. You can also change the course of your mortgage insurance payments by refinancing, or using a new loan with different terms to pay off the old one. In any case, when you cause an investor (your lending company) to take on a perceived increase in risk, they are essentially saying that you need to pay them for that privilege.
Calculating PMI Rates
An average figure for PMI is 1/2 percentage point annually. That means that if you purchase your home for $200,000, you would multiply that by one-half percent (0.005) to find your annual payment, and then divide that amount by 12 (or however many mortgage payments you make per year). This will give you the amount each month you can expect to be paying for PMI if your down payment is less than 20% of the total sales price of your home.