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How Mortgages Work


Private Mortgage Insurance

Private mortgage insurance (PMI) can help you snag the mortgage you want with a down payment of 20 percent or less. This is particularly helpful for younger buyers who haven't had the years to save but want to enjoy the tax benefits and investment aspects of home ownership. PMI is insurance that pays the mortgage in case you can't. It's protection for the lender, who is taking a greater risk with a borrower who has less equity. Lenders have discovered through experience and research that there is a definite correlation between the amount of money a borrower has put into the home and the rate of default on loans. The more equity in the home, the lower the rate of default.

Here is an example of how it works: If a couple has $10,000 in the bank, then they can buy a $50,000 home if they have to pay a 20 percent down payment. If they don't have to pay 20 percent, then that same $10,000 can be a 10 percent down payment on a $100,000 house or a 5 percent down payment on a $200,000 house. If they opt for the more expensive house, however, they have to pay for PMI. The costs for PMI are based on the loan amount. For a $100,000 loan with a 10 percent down payment, the average cost of PMI might be $40 per month.

In 1998, the Homeowners Protection Act established rules for mortgages signed on or after July 29, 1999, that require the automatic termination of PMI after you have reached 22 percent equity in the home, based on the original property value. You can also request that the PMI be dropped when you reach 20 percent if your mortgage was signed after that date. If your mortgage was signed prior to that date, you can request the cancellation of PMI once you've reached the magic 20 percent mark, but your lender isn't required by law to cancel it.

There are certain conditions that may make your loan an exception to this rule -- for example, if you haven't kept your payments current, if your loan is considered high-risk or if you have other liens on the property. Note that there are some states that have laws regarding early termination of PMI for those who signed mortgages before July 29, 1998.

Getting a mortgage is a lot harder than it used to be. Why is that? We'll examine two lenders and what led to the housing crisis on the next page.