Most people buying a home need to get a mortgage since it’s pretty rare for someone to pay the entire cost in cash. Even saving up for a down payment can be tough. As a result, many end up buying a house with little upfront cash. When this happens, lenders typically want some protection, which is where private mortgage insurance (PMI) comes in.
Private Mortgage Insurance (PMI) Explained:
When you buy a house, you usually pay part of the total cost upfront and then make regular installments for the rest. If your down payment is less than 20% of the home’s price, the lender will likely require an insurance policy to protect them in case you can’t make those payments. This policy is PMI.
How PMI Works:
Even though everyone aims to make their mortgage payments on time, unexpected events like job loss or medical bills can make it hard to keep up. If payments are consistently missed, it could lead to loan default. In such cases, having PMI in place protects the lender.
Protecting the Lender:
Lenders prefer homebuyers to make a 20% down payment as it reduces foreclosure risks, which can be costly due to real estate and legal fees, or possible property damage. When homeowners have this much equity, they are more committed to making payments. Lenders know it’s hard to save that kind of money, so they might provide loans with just 3% to 5% down, but they’ll require PMI to do so.
A Win-Win for Both Sides:
PMI helps both the lender and the borrower. The lender gets added security, while the borrower can buy a home sooner with less cash upfront. This insurance means homebuyers can start the ownership journey with a smaller down payment. Without PMI, lenders are less likely to approve risky loans.
Building Home Equity:
As you consistently pay your mortgage, your home equity grows. When you owe less than 80% of your home’s value, you might not need PMI anymore. The Homeowner’s Protection Act of 1998 allows you to cancel your PMI if you have a good payment track record and no additional mortgages on the property.
Tax Benefits:
According to IRS guidelines, U.S. residents can deduct PMI payments made to government or private insurers, starting from the 2010 tax year. It’s a good idea to check with the IRS or your accountant for more detailed information.