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Methodology of Private Mortgage Insurance

by Jennifer Cooper

Overview

Private mortgage insurance makes it possible for you to purchase a home even if you don't have the 20 percent of the purchase price most lenders require as a down payment. But as is the case with all insurance policies, you pay a premium, which the lender adds to your monthly mortgage payment.
Purpose of PMI

If you can't afford 20 percent of the purchase price for a down payment on a home, lenders see you as a bit of a risk. To mitigate this risk, they require you to pay for private mortgage insurance that will compensate them if you default on your loan.

Calculating PMI Premiums

In the early years of PMI, the borrower paid a significant premium upfront, typically 2.2 percent of the loan amount. These days, the premium for PMI is still determined by a flat rate, regardless of your credit history or income, but now it's part of your monthly mortgage payment. The premium is determined by the loan amount and the percentage of your down payment (see Resources). For example, if you put down 10 percent of the purchase price and took out a 30-year loan, your PMI rate would be .52 percent. If your loan was for $200,000, your annual premium would be $1,040 and your monthly payment would be $86.67 ($200,000 x .0052 / 12 = $86.67).
Canceling PMI

The Homeowners Protection Act of 1998 requires that lenders terminate PMI when your principal has been paid down to 78 percent if you are current on your mortgage (see Resources). But if you think the value of your home has increased such that you've reached the 20 percent threshold sooner than expected, you can request early termination. In the latter case, the lender will require that you haven't been 30 days late with a mortgage payment in the past year or 60 days late in the past 24 months. An appraisal also may be necessary to confirm that you have built up 20 percent equity, and paying for this is your responsibility. Appraisals typically cost $300 to $600, so do your research and make sure you have the equity you think you do before ordering one. You must pay for it, even if doesn't support your findings.