March 5th, 2012
Private mortgage insurance -- often shortened to PMI, or called lender’s mortgage insurance (LMI) -- is typically required if you buy a home with a down payment that's less than 20% of the final price.
PMI is protection for the lender against you defaulting on your mortgage. Historical data shows that homeowners who put down less than 20% have a much greater chance of failing to make their monthly payments. Whether or not you should have been given that loan in the first place is a different story; PMI is merely part of the social contract of not putting down a payment that represents a full fifth of the house.
The growing complexity of mortgage products in the banking sector (for better or worse) makes PMI all the more important because lenders are increasingly looking to package your mortgage alongside others to sell to banks for cash immediate cash. Private mortgage insurance acts adds an element of stability in an otherwise largely unregulated sector.
In most cases, once you have paid enough into the principle to get it down below 80%, you’ll no longer be on the hook for private mortgage insurance. Or you could get locked in for a fixed amount of time (often 2-3 years), even if you get the amount of principal owed gets down below 80% during that period. It all depends on the lender and your credit score.
A piece of good news is that of 2007, your yearly private mortgage insurance payments are tax deductible.
You can also look into alternatives, like agreeing to a higher interest rate on your mortgage. Though of course this is not much different -- in terms of added cost -- than paying for insurance. You could also consider an "80-10-10" strategy, in which you take out a traditional mortgage for 80% of the home's value, pay 10% down, and also take out a smaller loan for 10% of the home's value. That way you avoid technically owing more than 80% on your mortgage, thereby obviating the insurance. Obviously, after the near collapse of the economy in 2008 from many factors discussed in this piece, we don’t recommend getting too “creative” with your mortgage payments and responsibilities, but the “80-10-10” strategy is something you should at least consider.