Mortgage Insurance Basics

Mortgage insurance, commonly referred to as PMI or private mortgage insurance, plays a small but important role in our real estate economy. Because the insurance protects investors, it translates into more affordable and accessible loans for those Americans wanting to buy homes.

Private mortgage insurance-or PMI, as it's commonly called-is typically required by lenders when homeowners make down payments of less than 20 percent of a home's purchase price. The borrower pays PMI costs, even though this unique type of mortgage insurance doesn't pay claims to homeowners. Instead, it pays lenders if the borrower defaults, as a way to compensate for the lender's losses and the fact that the lender didn't require a hefty down payment up front. Without this mortgage protection insurance, lenders would have to shoulder more risk. Therefore, consumers get the indirect benefit of greater loan affordability when this kind of home mortgage insurance is in place.

Is PMI worth it?

To determine whether it's worth it or not to pay the additional cost of this rather quirky home mortgage insurance, you should get a firm mortgage insurance quote from a prospective lender. Then, compare the cost of PMI to the cost of coming up with a larger down payment, keeping in mind that if your funds don't go toward a down payment, they can be invested elsewhere. Carrying private mortgage insurance usually adds about $50 to $75 dollars a month to one's mortgage payment. But paying a smaller down payment adds to the overall amount of the loan and can be significantly more expensive over the lifetime of a typical mortgage. The math can get complicated in a hurry, so borrowers should have their lenders crunch the numbers with a mortgage insurance calculator and weigh all the various scenarios.

When mortgage insurance ends

By law, a lender cannot demand mortgage protection insurance from a borrower once the equity in the home reaches 22 percent. So, if you start off paying PMI and your equity rises to that level, you can drop those payments and enjoy the savings. Those paying for mortgage insurance can also benefit from a temporary tax break that makes PMI payments tax deductible as part of an economic rescue plan that went into effect at the end of 2007.

On the other hand, consumers may be able to skip the arithmetic and forego the mortgage insurance calculator exercises completely, thanks to the current mortgage crisis. Many banks are updating their loan requirements and stipulating that borrowers fork over 20 percent down payments under all circumstances. Whereas two years ago, it was common for banks to lend 100 percent of the value of a home, many cut that loan-to-value ratio to 90 percent in reaction to their own financial woes. As a result, some buyers can expect to pay 20 percent down on their loans regardless of what they prefer, and that means they won't have to worry about PMI-whether they like it or not.