Private Mortgage Insurance, more commonly referred to as PMI, allows home buyers to obtain a mortgage with a lower down payment (typically less than 20% of the sales price). With PMI in place, lenders are insured against the risk of default on the loan. PMI charges are fairly minimal, running at around one-half of one percent of the loan, on average.
Here is an example from Bankrate.com:
Let’s say you put down 10 percent or $10,000 on a $100,000 house. The lender multiplies the 90 percent loan, or $90,000, by .005. The result is an annual PMI of $450, which is divided into monthly payments of $37.50.
Most home buyers need PMI because 20 percent of the sale price on a home is a lot of money; for instance, that’s $20,000 on a $100,000 home. Home buyers must maintain the PMI premiums until they cross that one-fifth-of-principal threshold, a process that can take years in longer-term mortgages.
Obviously, when buyers pay down the loan to the appropriate level — less than 80% loan-to-value — it would be smart to call the lender and have the PMI removed. It is also important to keep an eye on the home valuation because if the home’s value increases, the loan-to-value will decrease.