What Is Private Mortgage Insurance?
Buying your first home is a very exciting thing. For the first time in your life, housing will no longer be purely an expense. Instead of shelling out money every month for the privilege of living somewhere, you will be building equity in your house. Furthermore, it is now your space, and you can decorate it the way you want. If you want to hang heavy pictures on the walls, you don't have to worry about the landlord having a fit because you hammered a nail or drilled a screw into the wall. If you think the ceiling light fixture in the kitchen is butt ugly, you can replace it with one you like better.
But buying your first home also comes with its challenges. As a first-time homebuyer, you won't have equity from a previous home to bring to the table when you purchase. If you have not saved at least 20% of the total cost of your home to use as a down payment, the lender will be very concerned about your commitment to repaying the loan. In order to protect themselves against the risk that you may decide to cut and run, or otherwise suddenly become unable or unwilling to make your monthly payments, they will require you to purchase Private Mortgage Insurance (PMI) on your loan.
The amount of PMI to be purchased is generally determined by the total value of the home relative to the amount financed. In some loans the PMI is paid upfront as part of the closing costs, but more typically it is a monthly charge that is part of one's monthly house payment. One might think that in this case, the PMI would go away once one has accumulated equity equivalent to a 20% down payment. However, lenders are under no obligation to allow the cancellation of PMI, and often the only way to get rid of PMI is to refinance one's home, which of course involves additional costs. You will want to calculate very carefully whether the savings of not having to pay PMI every month will balance out the closing costs of the refinance.
PMI exists entirely to protect the lender in case you fail to make the monthly payments. This insurance does not take care of anything else, so it should not be mistaken for any form of hazard insurance, which your lender will almost certainly require you to have as well. If your house were to burn down or be destroyed by a tornado, they do not want you to tell them that you will no longer be making payments on a home you can no longer occupy.
Obviously, the ideal solution is to be able to bring a 20% down payment to the table and not have to pay PMI at all. But if such a large down payment is simply overwhelming and not doable, PMI may be part of the price of making home ownership a possibility instead of a distant dream.
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