Definition:
Private Mortgage Insurance (PMI) is insurance that protects lenders if a borrower defaults on their home loan. PMI is typically required when a homebuyer makes a down payment of less than 20% of the property's purchase price.
Example:
Jessica buys a home priced at $250,000, making a down payment of only 10% ($25,000). Because her down payment is below 20%, her lender requires her to pay PMI each month, costing her an additional $100 monthly until she builds up 20% equity in her home.
Explanation:
PMI helps borrowers qualify for loans they might not otherwise obtain due to insufficient down payments. Since smaller down payments represent higher risks for lenders, PMI mitigates that risk by reimbursing the lender if the borrower defaults.
Typically, PMI costs between 0.3% and 1.5% of the original loan amount per year, paid monthly with the mortgage payment. The exact amount varies based on:
- Loan amount
- Borrower’s credit score
- Down payment size
- Loan Type
Once the homeowner reaches 20% equity—through regular payments, extra principal payments, or home value appreciation—they can request to cancel PMI. Lenders automatically terminate PMI when the borrower reaches 22% equity in the property.
Why is Private Mortgage Insurance Important in Real Estate Transactions?
PMI is important because it enables buyers who can’t afford large down payments to purchase homes, expanding homeownership opportunities. Buyers benefit from understanding PMI because it significantly affects monthly mortgage costs and overall home affordability. Sellers also benefit, as buyers using PMI financing can increase the pool of potential purchasers for their homes. Awareness of PMI ensures transparency about the total cost of homeownership and helps buyers make informed financial decisions throughout the real estate process.