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By Doreen Martel

Understanding private mortgage insurance

When purchasing a home or refinancing your current loan, borrowers need to understand how private mortgage insurance works. Private mortgage insurance is known as PMI or MI; it is an insurance policy that benefits lenders. In the event a homeowner defaults on their mortgage, the insurance is designed to protect them from a significant loss.

What loans require private mortgage insurance

Private mortgage insurance is required on nearly all loans when the equity in the home is less than 20 percent of the value of the property. The one exception to this is with VA-backed loans; these loans do not require private mortgage insurance. The rule of thumb is simple: if a buyer purchases a property with less than 20 percent down or refinances a current mortgage with less than 20 percent equity, PMI will be required.

Paying for private mortgage insurance

Mortgage insurance is paid for by the borrower in all instances. FHA loans have their own rules regarding mortgage insurance premium payments, borrowers pay an upfront premium then make premium payments throughout the life of the loan. Other loans follow one of three methods for collecting mortgage insurance premiums:

  • Upfront payment of premium in some instances, lenders will require borrowers to pay the premium for the insurance upfront. This will be listed on the disclosure documents in the loan package.

  • Monthly premium payment – most mortgage insurance premiums are paid on a monthly basis as part of the mortgage payment. This will be disclosed in the payment section of a borrower’smortgage loan package.

  • Upfront and monthly premiums – while far less common, some lenders will use a hybrid similar to the FHA model which includes an upfront payment and ongoing monthly payments.

Many borrowers are told their mortgage insurance payments are included in their mortgage and they are not responsible for paying the premium. Borrowers need to ask questions if this is what they are told. In some cases, lenders will increase the interest rate charged to a borrower and pay the premium themselves. Any borrower who knows their loan to value exceeds 20 percent of the property should make sure they understand how the mortgage insurance premiums are being paid.

Canceling mortgage insurance

With the exception of FHA loans which must be refinanced to eliminate PMI payments, borrowers have the right to request the premium be stopped under specific circumstances. For mortgage loans closed after July 29, 1999, the Homeowners Protection Act gave consumers specific rights of cancellation. There are some important rules that must be met if a borrower is to be eligible for cancellation.

Borrowers must be current on their mortgage payments and have a good payment history on the mortgage to request cancellation of private mortgage insurance. One of the most important requirements is the value of the property must be high enough; borrowers must be able to prove they have 20 percent or more equity in the property. This may require the homeowner to pay for an appraisal. These requests must also be made in writing, lenders may challenge the homeowner unless there is clear evidence of the home value.

Borrowers should also review their closing documents because in these documents, the lender is required to cancel or terminate PMI if the home mortgage is more than 50 percent satisfied, regardless of the value of the property. This means if a borrower took out a 15-year loan and has been paying on that loan for seven and a halfyears, the lender must terminate any further mortgage insurance payments.

Consumers should always be aware of what rights they have, particularly when those rights pertain to one of the most significantfinancial decisions they will make in their lifetime. There are many aspects of mortgage financing that are confusing and mortgage insurance is one of them; borrowers should ask their lenders how they handle PMI before signing their final loan documents.

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