Before the mortgage bubble, buying a house required a down payment of at least 20%. It was just a given that before buying you had to save up. To get around that requirement many people simply started to take out two mortgages. One was for 80% of the loan, and one was for the remaining 20%. The second loan would have a slightly higher interest rate, but it would allow people to get a home with little to nothing down. For those who do not want to go through the hassle of two loans, there is a way to finance the entire purchase, with one loan, by using mortgage insurance.
Also called Private Mortgage Insurance, or PMI for short, this coverage is set up to protect the lender, not the borrower. The lender purchases mortgage insurance to protect them in the event that buyer defaults on the loan. And rather than simply write off the coast of the insurance, the mortgage insurer makes the borrower pay for it. In the end, the borrower pays the equivalent of about .5% – 1% of the original loan amount per year in order to protect the lender. The only benefit to the borrower is that they can get into a house before they have 20% equity in it.
PMI is not needed throughout the entire length of the loan. Once the buyer has 20% equity in their home, they can request a new appraisal, and assuming the house has not lost value, the lender is required to drop the PMI. The catch is that the buyer has to pay for the new appraisal, which can sometimes run upwards of $500. Before 1998 the only way to have the PMI dropped was for the homeowner to request it to be dropped. There were some unscrupulous lenders out there that would keep charging the owner even though the insurance was no longer needed. Now, with the passage of the Homeowners Protection Act of 1998, legally the lender must drop the PMI coverage when the owner’s equity hits 22%.
Unfortunately for those who want to get a loan for more than 80% of the cost of the house, there is no way to get around the requirement for private mortgage insurance. But for those who are paying for the insurance, they can take consolation in the fact that the premiums are tax deductible.