What Is Private Mortgage Insurance (PMI)?
Private Mortgage Insurance (PMI) is a type of insurance policy designed to protect mortgage lenders from the risk of borrower default. Offered by private insurance companies, PMI is typically required for homebuyers who are unable to put down at least 20% of the home’s purchase price as a down payment.
With less than the conventional 20% down payment, borrowers indirectly mitigate the lender’s risk by agreeing to obtain PMI. This insurance makes it possible for homebuyers to qualify for a mortgage with a smaller, more manageable down payment, enabling them to secure their dream home sooner.
Costs Associated with Private Mortgage Insurance
Borrowers required to carry PMI often pay approximately 0.5% of the total borrowed loan amount annually. However, PMI premiums are generally not tax deductible, adding a notable expense to the overall cost of the mortgage. Understanding this cost is crucial for prospective homeowners as they budget for their purchase.
Removing Private Mortgage Insurance: A Cost-Saving Strategy
One noteworthy advantage for borrowers with PMI is the possibility of cancellation. Once the borrower has paid down enough of the mortgage principal, typically achieving 20% equity in the home, they can request the removal of PMI. Verification and procedures for PMI cancellation will vary among lenders, but this milestone offers significant potential savings over the life of the loan.
Related Terms: mortgage lender, down payment, principal, home loan, insurance premium.
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### What is Private Mortgage Insurance (PMI)?
- [ ] Insurance for homeowners in case of loss or damage
- [ ] Insurance to protect real estate agents from losses
- [x] Insurance offered by a private company to protect the lender
- [ ] Insurance for renters in case of property damage
> **Explanation:** Private Mortgage Insurance (PMI) is a type of insurance that protects the lender from losses if the borrower defaults on the mortgage. It is typically required when the borrower cannot make a down payment of at least 20% of the home's purchase price.
### When is a borrower usually required to obtain PMI?
- [x] When they have less than 20 percent down payment
- [ ] When they have a poor credit score
- [ ] When they are a first-time homebuyer
- [ ] When they have over 20 percent down payment
> **Explanation:** A borrower is generally required to obtain PMI when they put down less than 20 percent of the home's purchase price. This insurance protects the lender against the added risk of the smaller down payment.
### How much is the typical annual cost of PMI for borrowers?
- [ ] 1 percent of the loan amount
- [ ] 2 percent of the loan amount
- [x] One-half of one percent of the loan amount
- [ ] 5 percent of the loan amount
> **Explanation:** The typical cost of PMI is about one-half of one percent of the loan amount annually. This is paid by the borrower in addition to their regular mortgage payments.
### Are PMI premiums tax deductible?
- [ ] Yes, always
- [ ] Sometimes, depending on the borrower's income
- [ ] For loans taken before a certain date
- [x] No
> **Explanation:** PMI premiums are not tax deductible, which can make the cost of PMI more burdensome for borrowers.
### After paying what percentage of the principal might a borrower be able to discontinue PMI?
- [ ] 10 percent
- [ ] 15 percent
- [x] 20 percent
- [ ] 25 percent
> **Explanation:** A borrower may be able to discontinue PMI after they have paid down 20 percent of the principal. This reduces the loan-to-value ratio, which lowers the lender's risk.
### What is the main benefit of PMI for borrowers?
- [ ] It lowers the interest rate on the mortgage
- [x] It allows borrowers to get a mortgage with a smaller down payment
- [ ] It provides tax benefits for borrowers
- [ ] It eliminates the need for homeowners insurance
> **Explanation:** The primary benefit of PMI for borrowers is that it allows them to get a mortgage with a smaller down payment. This is particularly beneficial for those who are unable to save up a full 20 percent down payment.
### Who benefits directly from the protection offered by PMI?
- [x] The lender
- [ ] The borrower
- [ ] The insurance company
- [ ] The government
> **Explanation:** PMI directly benefits the lender by protecting them from losses if the borrower defaults on the mortgage. It does not directly protect the borrower, although it enables them to obtain a loan with a smaller down payment.
### What might trigger the discontinuation of PMI?
- [x] Paying down 20% of the mortgage principal
- [ ] Making timely payments for one year
- [ ] The borrower's credit score improving
- [ ] The home increasing in value
> **Explanation:** PMI can typically be discontinued once the borrower has paid down 20% of the mortgage principal. This is because the risk to the lender decreases when the borrower's equity in the home increases.
### Which party usually requires PMI if the down payment is less than 20 percent?
- [ ] The borrower
- [ ] The government
- [ ] The insurance company
- [x] The lender
> **Explanation:** The lender typically requires PMI because it helps offset the risk associated with a smaller down payment.
### What is the typical down payment amount that allows a borrower to avoid PMI?
- [ ] 10 percent
- [ ] 15 percent
- [x] 20 percent
- [ ] 5 percent
> **Explanation:** Typically, a borrower needs to make a down payment of at least 20 percent of the home's purchase price to avoid needing PMI.
