Mortgage lenders typically require a 20 percent down payment for a conventional mortgage loan. If you can't put 20 percent down, you need to find another way to lower the mortgage company's risk. That's where mortgage insurance comes in. Mortgage insurance takes some of the risk off the table and makes your lender willing to accept a lower down payment.
Mortgage insurance is an insurance policy that you pay for, but that your lender is the beneficiary of. Sometimes referred to as private mortgage insurance, or PMI, the policy insures your lender against loss in the event you default on your mortgage loan.
PMI vs. Homeowners Policy
Mortgage insurance has nothing to do with your homeowner's insurance policy. Your homeowner's policy insures you against financial loss if your home is damaged because of a covered event, such as a fire or storm. Most homeowner's policies also include personal liability insurance that covers you if someone gets injured on your property. Mortgage insurance is a separate policy that protects your lender, not you.
When you put at least 20 percent down on your home, you have considerable skin in the game. Your mortgage lender feels that you are less likely to default on your loan because you have substantial equity in your home, so it is more willing to make the loan. Mortgage insurance serves the same purpose of reducing the mortgage lender's risk. Since the risk level is reduced, the mortgage company might be willing to take a significantly lower down payment; in some cases as low as 3 to 5 percent.
You might be able to deduct your mortgage insurance payments. The tax break for mortgage insurance which was initially created in 2007 was due to expire at the end of 2012, but was extended at least through the end of 2013. You must itemize your deductions if you want to write off your mortgage insurance premiums.
Request for Cancellation
Under the Homeowner's Protection Act of 1998 you can usually request to have your mortgage insurance policy canceled once the equity in your home exceeds 20 percent of your home's appraised value, or when you've paid your mortgage down below 80 percent of your home's original purchase price. If you have been late on your mortgage payments during the past couple of years, your lender might consider your loan to be a high-risk mortgage. High risk loans might require greater equity before PMI can be canceled.
- Jupiterimages/Brand X Pictures/Getty Images