What is Mortgage Insurance (or PMI) and Why do You Need it?

Mortgage insurance (MI) is an insurance policy that helps protect the lenders in case the borrower defaults on their loan. In the event of the borrower defaulting, the insurance policy will protect the lender up to a stated percentage of the property's value (typically around 15-20%).

Federal law states that any individual who has less than 20% equity in their home must carry MI in order to protect the lender, equity being the amount of the home you own. For example, if you purchased a house for $100,000 and put $5,000 (5%) down, you would own that 5% and have 5% equity in the home. From a high level overview, MI is to protect financial institutions and help prevent another financial crisis like the '08 Mortgage Crisis.

When you own 20% equity in your home, therefore are only financing 80%, you have the option to legally opt out of MI which will lower your monthly payment. If you do not opt out when you reach that 20% equity level at 22% equity the policy automatically ends for you.

If you are able to put 20% down on the home, you do not have to carry MI and will save a significant amount of money. If you are unable to put 20% down, try to overpay your monthly payments in the beginning in order to reach that 20% equity mark faster. The quicker you reach the 20% mark, the more you will save. To give some perspective, if you purchased a $100,000 home and put 5% down you would owe the lender $95,000. Your monthly payment would be about $950 (dependent upon interest rates, credit, etc.) of that, only $323 would be going to the principal balance. So, it would take you around 48 payments (4 years) to reach that 20% equity mark. In the meantime, you are paying an extra $50 per month for MI ($2,400 over that span). If the value of your home is higher, your MI savings will be larger.

If you neglect to get MI after the purchase of your home, the lender can force coverage on the borrower which typically carries a significantly higher monthly premium (nearly double in many cases). Ultimately, until you hit the 20% equity mark, there is no way around paying for Mortgage Insurance.