Chances are if you've taken out a home loan with a down payment of 20 percent or less, you've been introduced to private mortgage insurance, or PMI. But what many homebuyers may not know is that PMI isn't insurance that protects you, but your lender.
Let us explain…
What is private mortgage insurance?
According to the Insurance Information Institute (III), PMI is extra insurance that lenders may require homebuyers to purchase if they take out a loan that's more than 80 percent of their home's value. For example, if your home is appraised at $200,000 and your mortgage balance is $160,000 or more, chances are you'll be required to carry - and pay for - PMI. And even though PMI provides coverage for the bank only, it's the homeowner who pays the premiums.
PMI exists because it's the lender who is taking the greater risk. By offering a loan to applicants who are unable to afford a 20 percent down payment, PMI provides these individuals with an opportunity for homeownership. Therefore, lenders require applicants to purchase this type of insurance to protect their interests in case you default on your loan.
How does private mortgage insurance work?
PMI is paid monthly, on top of your principal, interest, taxes, and homeowner's insurance. Once your loan balance is paid down to 80 percent of the property value, and you have a favorable payment history, lenders will often drop the PMI coverage requirement.
However, the responsibility for keeping track of the loan balance falls on you, the borrower. So when the time comes, it's up to you to request that the lender drop the PMI coverage. If you don't, you could end up paying months or even years of unnecessary premiums-which can range anywhere from $250 to $1,200 per year.1
What you need to know about private mortgage insurance
The problem with PMI is that it's often mistaken for a life insurance policy - which it is not. If you're a new homeowner and looking for insurance that will help pay off your mortgage in the event of your death or incapacitating disability, then you'll need to buy a life insurance policy.
When you speak to your insurance agent about getting your new homeowner's policy in place, ask him or her to run some life insurance quotes. If you're married, be sure to get quotes for the both of you, so the other spouse will have enough to pay off the mortgage loan in full should one of you die.
When getting quotes, you want to make sure that the death benefit is high enough to at least cover the balance of your mortgage, and if you select a term life insurance policy, that the policy term is equal - or as close as possible - to your loan's term (think 25 or 30 year term).