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How Does PMI Insurance Work?

Private mortgage insurance (PMI) is a rather simple form of protection that is thought to be rather confusing, by most, for a variety of reasons. In any case, the basics of the insurance are easy to follow.

When one purchases a home, he or she will likely need to apply for financing, called a mortgage. This mortgage loan supplies the home’s seller with the sales price in full, at one time; the home buyer then pays the company that supplied these up-front funds back over a selected period of time, with interest.

In the process of applying for financing and purchasing a home, one will also need to place a lump sum of cash down, called a down payment. This money is paid up-front, as a home is purchased, and offsets the cost of the home for creditors, resulting in lower interest rates for the customer. Basically, the higher the down payment that a buyer provides, the lower their mortgage interest rate, as creditors aren’t supplying as much money (or taking as much of a financial risk) now that the amount of the home payment has been reduced by this down payment.

Accordingly, creditors place a large value on this down payment, as it relieves a great deal of stress and risk for the credit that they provide. If a buyer is unable to supply a down payment of at least 20% of a home’s value, he or she will need to purchase PMI insurance to qualify for a mortgage loan. This insurance will pay the creditor some of the lost money on the loan, should the buyer default (and there is a pronounced chance of this happening, in their eyes, based upon the down payment which was supplied).

This insurance costs a portion of the initial loan amount, and relates directly to the amount of money that one paid-down towards the home. Someone who supplied 10% of the home’s value in the form of a down payment will pay more in PMI insurance, while someone who paid 17% will pay less, and so forth.

This additional fee shouldn’t be over-stressed, either; creditors are required by-law to cancel mandatory PMI subscriptions once 20%-22% of a home’s initial value has been paid off (in the vast majority of instances). This process can be sped up by increasing the amount that is paid towards the mortgage per month, so that the principal of the loan is reduced.

So there it is: the ins and outs of PMI insurance. As was mentioned, it may appear daunting at the outset, but many will find that it’s much simpler than was expected, when broken down. In short, (for those readers who like to skip to the end!), PMI insurance reduces the risk assumed by creditors from home buyers who don’t supply a 20% (of the home’s value) or greater down payment by offering a payment in the case that the buyer defaults on mortgage payments. As was also mentioned, this insurance will cease once 20%-22% or more of a home’s initial value has been paid in the form of mortgage payments.

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