Mortgage insurance sometimes gets a bad rap. “Avoid PMI” or “eliminate your private mortgage insurance payment” is what you might hear. But while mortgage insurance does sometimes get underappreciated, private mortgage insurance, or PMI, is actually a good thing and doesn’t have to be something you should avoid at all costs.
Private mortgage insurance was introduced in the late 1950’s by a company that thought of an insurance policy that would cover the difference between a down payment and the amount borrowed. Back then, and still today, any conventional loan whose balance exceeds 80% of the appraised value, the lender requires PMI. Say that a buyer has 5.0% down on a home listed at $200,000. The down payment is $10,000 leaving a loan amount of $190,000.
Because the loan amount is more than 80% of the value, a PMI policy is required. In this example, the policy would protect the lender in case of default for the difference between $10,000 and 80% of the value, or $160,000. The policy covers $30,000 should the loan go into default. Without the availability of PMI, the buyers would have to come up with 20% down for this loan which they didn’t have. PMI is typically paid in monthly installments, and can vary in amount based upon the amount of down payment, loan term and credit score.
And PMI isn’t a “forever” thing. Once the loan balance naturally amortizes to around 78% of the original sales price, borrowers can have PMI removed. Or, if property values have increased since the original purchase and the borrowers can point out the current balance is less than 80% of the new value, PMI can also be waived. Borrowers can also pay down a mortgage to the appropriate level.
Over the years, PMI has been eligible as an income tax deduction, just like mortgage interest. Yet the most recent legislation allowing for the tax deduction expired on December 31 of last year. You can still deduct 2016 PMI but Congress is going to have to act to reinstate the deduction for 2017. In all likelihood Congress will because it always has. But until such time this happens, it’s not a sure thing.
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