How Private Mortgage Insurance (PMI) work?
1. Initial Requirement: When a borrower applies for a conventional mortgage loan and makes a down payment of less than 20% of the home’s purchase price, the lender will typically require PMI. This is because a down payment of less than 20% represents a higher risk for the lender, as the borrower has less equity in the property.
2. Cost and Payment: The cost of PMI is calculated as a percentage of the loan amount and is typically paid on a monthly basis as part of the borrower’s mortgage payment. The exact cost of PMI depends on factors such as the loan amount, down payment amount, and borrower’s credit score. PMI payments are made until the borrower’s equity in the home reaches 20%.
3. Lender Protection: In the event that the borrower defaults on the mortgage and the lender forecloses on the property, PMI provides protection to the lender by reimbursing them for a portion of the outstanding mortgage balance. This helps mitigate the lender’s losses in case of foreclosure.
4. Cancellation: Borrowers have the option to request the cancellation of PMI once their equity in the home reaches 20% or more. This can be achieved through a combination of factors, including appreciation of the home’s value, mortgage payments, or a combination of both. Lenders are also required to automatically cancel PMI once the borrower’s equity reaches 22% of the home’s original value, based on the initial amortization schedule.
5. Types of PMI: There are different types of PMI arrangements, including borrower-paid PMI, lender-paid PMI, and single premium PMI. Each type has its own implications for the borrower’s monthly mortgage payment and overall cost.
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