Anyone who has a mortgage or is about to acquire a property loan needs to understand PMI, also known as private mortgage insurance, and how it’s funded in a loan. It’s equally important to know what is included in your escrow account, since escrow requirements increase your monthly mortgage payments. Fully understanding both topics will allow you to confirm you’re only paying what’s required by the terms of your loan and nothing more.
An Explanation of PMI
Private mortgage insurance is required when a buyer contributes less than 20 percent to the down payment on a property loan. This insurance protects the lender in case the buyer defaults on the loan. When attempting to secure a home loan, it is always prudent to specifically ask if PMI will be required, as well as the total cost of this insurance for your loan before you make a loan commitment.
Escrow accounts are basically reserves a lender requires a borrower to fund that pay for expenses associated with a loan. These expenses can include property tax, homeowners insurance, flood insurance or private mortgage insurance. The requirements may vary based on the type of loan or property mortgaged. Typically, monthly escrow values are calculated by adding the total of all annual expenses to be paid through the lender and dividing that amount by 12.
PMI Payment Methods
Although private mortgage insurance can be paid as a lump sum at the closing of a loan, not many buyers opt for this method of payment. PMI is more commonly included as part of the escrow reserve account. Lenders are obligated to disclose PMI requirements at the time of the mortgage transaction and, once established, the amount of a PMI payment cannot fluctuate.
How to Eliminate PMI Payments
The Homeowners Protection Act of 1998, also known as the PMI Cancellation Act, sets out specific provisions for the elimination of PMI payments. The basic premise of the PMI Cancellation Act is to cancel the requirement for private mortgage insurance once a homeowner’s equity reaches 22 percent of the original value of the property, since the perceived risk of default is then lower. Lenders are further required to disclose PMI cancellation terms on an annual basis; however, a wise homeowner should monitor loan values to make sure PMI is removed once the appropriate thresholds have been met.
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