If you have the income and the credit to buy a home, but can't put a lot of money down, don't despair. Private mortgage insurance (PMI) reduces your lender's risk by compensating your lender if you end up in foreclosure. When you get your mortgage, your lender will get the PMI for you, and you'll make payments on your PMI along with your mortgage each month.
PMI Doesn't Protect You
PMI protects the lender. You still have to pay the premiums, but if you lose your job or get sick and can't pay the mortgage, it doesn't do a thing for you. Instead, the PMI pays your lender in case you default on your mortgage loan. The moral of this story is: If you don't have the ability to sock away enough in savings to cover your mortgage payments in case you lose your income, think twice about buying a home.
You May Not Need It
Buyers are required to get PMI is they don't have a 20 percent down payment on a house. If you save a lot of dough, or settle for a less expensive house, you can avoid PMI altogether. Another option is to take out a separate loan for the down payment, though this will compromise your debt-to-income ratio and lower the amount of money you can borrow.
PMI Isn't Forever
If you bought your home before July 29th, 1999, the federal Homeowners Protection Act of 1998 may require your lender to terminate your PMI once you have 22 percent equity in your home. The law also gives you the right to request PMI cancellation once you hit 20 percent equity, though the lender doesn't have to grant your request. However, you don't have a right to mandatory PMI cancellation if you have an FHA or VA mortgage or PMI that's paid by your lender. Plus, if your house payments aren't current, don't bother asking until you have at least 12 months of on-time payments under your belt.
You'll Need an Appraiser
Your lender will certainly want an appraisal if you request PMI cancellation once you've hit 20 percent equity, and may request an appraisal once your mortgage payments top 22 percent of your home's original value. In fact, the lender may even get to choose the appraiser (and yes, you get stuck with the bill). If you've made enough mortgage payments to cover 22 percent of your home's original selling price, the lender may still request an appraisal to ensure that your property hasn't decreased in value.
Quick Equity Building
If your home's value increases, that's more equity for you. So if you make it more energy efficient, do some remodeling or generally fix up the place, you can reach that 20 to 22 percent equity sweet spot faster than you think.
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