	How to Buy a House	As seen in BusinessWeek and Realtor Magazine
	a free 38-page guide by Michael Bluejay Š2000-2010

Private Mortgage Insurance (PMI)

What it is, how to cancel it

When your down payment is less than 20% you usually have to pay for Private Mortgage Insurance (PMI). This protects the lender in case you don't make your house payments. This doesn't mean you can blow off making your house payments -- if you fail to pay, the bank will still repossess your house. The insurance company will pay the bank the difference between 20% and the amount you actually put down. If you put down 5% and default, the insurance company pays the bank the other 15% that you didn't pay.

So the bank gets protected and you get to pay for their protection. What's in it for you? What's in it for you is that you get to buy a home for less than 20% down! Used to be that banks wouldn't give you a loan under any circumstances unless you made a large down payment because they felt it was too risky. But now with PMI banks will take loans with as little as 5% down. That makes it much easier for you to get into a home.

The PMI premium is paid monthly as part of your mortgage payment. The amount varies according to the size of your down payment. Here are typical rates:

If your down payment was...

Divide the mortgage amount by this number to get your monthly cost

5%

1500

10%

2300

15%

3700

For example, let's say you buy a $100,000 home and put 5% down. Your down payment is $5,000 and the morgtage is $95,000. Divide the $95,000 mortgage by 1500 and you get your monthly PMI cost, $63.

Canceling PMI

Remember, PMI is just to protect the lender for the amount that your down payment is below 20% of the house price. So you don't need it once you've made enough payments on your house that you own 20% of it.

It used to be that the insurance company would keep happily charging you the premium forever, since many homeowners didn't know they could cancel. But starting in 1999 insurance companies are required to automatically cancel your PMI once you own at least 22% of your home, based on the original purchase price. Here's how long that will take depending on the length of the loan and the interest rate:

Time it takes to own 22% of your home
(for 5% / 10% and 15% down payments)

Interest Rate 15-year Mortgage 30-year Mortgage

6% 4 / 3 / 2 years 10.5 / 8.5 / 5.5 years

7% 4 / 3.5 / 2 years 11.5 / 9.0 / 6.5 years

8% 4.5 / 3.5 / 2.5 years 12.0 / 10.0 / 7.0 years

9% 4.5 / 3.5 / 2.5 years 13.5 / 11.0 / 8.0 years

10% 5 / 3.5 / 2.5 years 14.5 / 12.0 / 9.0 years

From this table you might think "Wait a minute -- on a 30-year loan I should own about half of my house after about 15 years, but with a 10% interest rate and a 5% down payment you're saying I'd own only 22%?! What gives?"

The answer is that banks use compound interest, so your equity grows slowly. On a 30-year loan of $100k at 7%, the payment is $665/mo., but when you make the first payment, a whopping $583 goes to interest, and a mere $82 goes towards owning the home. On 15-year loans a much higher percentage goes towards the home itself, which is why 15-year mortgages are a better deal if you can get them -- and why you should try to pay off your loan in 15 years anyway if you can't. There's more on this in our section about paying off a loan early.

But let's get back to PMI and canceling it. Of course, you don't have to wait for the automatic cancellation at 22%. You can write to the insurance company and ask them to cancel your PMI coverage as soon as you hit 20% equity.

And here's one more thing you can do: If your house has increased in value then you suddenly own a lot more of it. For example, let's say you put $5,000 down on a $100,000 home, and in a couple of years the value shoots up to $119,000 because it's a hot real estate market. You own the $5000 you put into the house, plus the $19,000 it increased, for a total of $24,000. (You also own the equity you built from making mortgage payments, but because of compound interest it's not very much for the first few years so we'll ignore that.) So the $24,000 you own divided by the $119,000 value of the home means you own over 20% of your home. Now you don't need PMI any more. But to cancel the PMI you'll need to convince the lender that your home is really worth $119,000 now, so you'll have to pay for an appraisal. You'll have to weigh the cost of the appraisal against the amount you'll save by canceling PMI early to see if it's a good deal for you.

When PMI is canceled automatically and when it isn't

Don't assume your PMI will be canceled automatically. Check this table.

Canceled Automatically
if ALL are true

Not Canceled Automatically
if ANY are true

Conventional loans

FHA and VA loans

Loan signed on or after July 29, 1999

Loan signed earlier than that

All mortgage payments have been made on time in the year prior to PMI cancellation

Any mortgage payments have been late

Buyer is not considered high risk

Buyer is considered high risk

How much will I pay for PMI?

Here are some rough estimates for how much you'll pay for PMI.

For the monthly cost, I'm dividing the loan amount by 1500, 2300, and 3700 respectively for 5%, 10%, and 15% down loans.

PMI Calculator

Loan Amount

$

Down Payment

Interest Rate

%

Monthly PMI cost (est.)

$

Total PMI costs over the life of the loan

$

For the total cost, I'm using the formula:

Loan Amount * (Interest Rate + 0.021) * Loan Percentage (i.e., 0.95, 0.90, or 0.80) ^ 13 * 2

If you're wondering where I got the 2.1 percentage points, the exponent of 13, or the multiplication factor of 2, those are simply the numbers I found that worked best to get reasonably accurate results. They don't stand for anything. If you can come up with a better formula, I'm all ears.

References

Article examining the overall advantage of PMI to homeowners, Auburn University, 1997