Private Mortgage Insurance BasicsPrivate mortgage insurance is usually required when you take a mortgage loan. In fact it is generally included in your mortgage payment and placed in an escrow account along with any tax liability. This protects the lender against any inability on your part to pay the full annual lump sum when it is due. Must you have it? First let’s discuss why you need it.

What is the Purpose of Private Mortgage Insurance (PMI)?

The purpose of private mortgage insurance is to provide security to the lender in case you cannot afford to repay the mortgage loan. When that happens the lender forecloses. The house is then sold, but the sale might not raise enough to meet the balance still owed on the loan. Private mortgage insurance pays the difference to the lender.

It might seem unfair that you must pay for an insurance that benefits the lender. However, if it wasn’t paid, the lender would likely increase the mortgage interest and so raise the insurance premium that way. Whatever way it is paid, lenders will cover themselves in case of non-payment.

Is Private Mortgage Insurance Essential?

No. If your deposit or down payment is at least 20% of the purchase price of your home you can avoid this. That’s because, if you do default on your mortgage payments, then the sale would raise sufficient to repay your debt.

If your down payment is less, it is still possible to avoid this type of mortgage insurance. You must set this up when you purchase the property. Here’s how:

a) Arrange a mortgage for 80% of the sale price of your new home.

b) Then arrange a second mortgage on the home for 10-15% of its value.

c) Have 5% – 10% as a down payment.

Use all three of these to purchase your home. Because the first mortgage is for only 80% of the value of your home, you do not have to take a private mortgage insurance policy.

Sure. You will pay a higher interest rate on the 10%- 15% second mortgage, but that will be less than your insurance premium would cost. However, since mortgage insurance payments are now tax deductible, the benefit of avoiding this type if insurance is not as great as it once was.

How Much is PMI?

The cost varies according to your LTV (loan to value ratio), the amount you are borrowing and also on your credit score along with a few other factors. The greater the risk you appear to be (i.e. the more likely the lender thinks you will default), the higher your insurance premium. In fact, prices for private mortgage insurance vary from around $250 to over $1250 per annum.

If the LTV is 95% (you make a down payment of 5% on a $300,000 home) you will pay an initial 1% on your $285,000 loan – or $2,850 immediately. You will then pay an annual payment around 0.85% of the total loan = $2422.50 payable at $201.87/month.

That is a sizable sum, and certainly worth saving if you can spend that money instead on repaying a second mortgage. Private mortgage insurance is expensive, so you should consult a mortgage advisor for help in finding out the best way for you to avoid paying this.

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