When your down payment on a home is less than 20% of the purchase price you must pay private mortgage insurance, which insures the lender in case of the borrowing defaulting on the loan.  The borrower pays the insurance premium each month which is included in the monthly mortgage payment.

According to the Mortgage Bankers Association, the PMI is generally about 0.5% of the loan balance, annually. For a $200,000 loan, this equates to an annual PMI premium of $1000, or $83.33 per month added to your mortgage payment.

What’s in it for You?

You might be thinking, why should the borrower pay monthly PMI premiums for the protection of the lender?  It’s a valid questions; generally insurance premiums are paid by the beneficiary of the insuance policy to guard against some unexpected expense, event, or other loss.

Well, a short generation ago lenders would not make home loans with less than a 20% down payment.  This meant our parents had to save up enough money to put a large down payment on a house before they could become homeowners.  Even if they went to college and came out of school with a high paying job they could not immediately buy a house until they had saved enough for a down payment.  Borrowers that put less than 20% down are a higher risk of defaulting on the home loan.  PMI is the price you pay for not putting 20% and being able to buy a home with small down payments.

Canceling PMI

The good news is you are able to cancel PMI under certain conditions.  Once your percentage of equity in your home is 20% or greater you can request that your lender cancel the PMI.  As you make payments on your house your equity will increase, albeit slowly at first, and it will likely take many years to build 20% equity in your home.  But your home also appreciates in value, which also increases your equity at the same time.  Paying additional payments towards principle and home improvements (additions and home upgrades) will also increase your equity.

To calculate your equity, estimate the value of your home and subtract the outstanding mortgage balance.

Home Equity = Home Value - Mortgage Balance

To calculate your percent equity, divide the home equity by to home value.

Percent Equity = Home Equity / Home Value

If your percent equity is .20 (20%) or higher, you should contact your lender and inquire about canceling PMI.  You will have to obtain a home appraisal (most likely at your expense) and make a formal written request to the lender, but your lender will be able to provide you with the details and necessary forms.