It's a financial guaranty that insures lenders against loss in the event a borrower defaults on a mortgage. If the borrower defaults and the lender takes the title to the property, the mortgage insurer (MGIC, for example) reduces or eliminates the loss to the lender. In effect, the mortgage insurer shares the risk of lending the money to the borrower.
Benefits of Mortgage Insurance
First-time homebuyers, and other savings-poor-but-income-rich buyers, stand to benefit most. PMI allows them to buy a home without having to save for a 20 percent down payment. They can use a low down payment to help them afford their first home, or to purchase a more expensive home sooner.
Repeat homebuyers can put less money down and gain significant tax advantages because they will have more deductible interest to claim.
Private Mortgage Insurance
If your down payment on a home is less than 20 percent of the appraised value or sale price, you must obtain private mortgage insurance, known as PMI, with your lender. This lets you to secure a mortgage with a lower down payment because your lender is now protected against any default on the loan.
PMI charges vary depending on the size of the down payment and the loan, but they typically amount to about one-half of 1 percent of the loan.
Insuring Mortgage Essential
Never confuse mortgage insurance with mortgage life insurance, which provides coverage in the event of a borrower's death, or homeowner's insurance, which protects the homeowner from loss due to damage from fire, flood or other disaster. Keep track of your payments on the principal of the mortgage.
When you reach the point where the loan-to-value ratio hits 80 percent, notify the lender that it is time to discontinue the PMI premiums.