PMI, or private mortgage insurance, is a policy that allows borrowers to buy a home with a down payment smaller than 20 percent. The purpose is to protect the lender in case the borrower defaults on the loan, as stated by Bankrate.
With a private mortgage insurance policy, the borrower is responsible for paying the monthly premiums, which is rolled into the monthly payment in addition to principal and interest, while the lender is the beneficiary. If the borrower defaults on the mortgage, the policy payout keeps the lender from losing as much money, according to Bankrate.
If a person buys a $350,000 house and makes a 10 percent down payment, he borrows $315,000. If the private mortgage insurance company charges a yearly premium of 0.61 percent, that means an annual PMI premium of $1,921.50 (the loan times the interest rate), or a monthly premium of $160.13. However, the borrower does not have to pay this premium for the entire life of the loan. At closing, the borrower should receive a statement indicating how long it takes him to reach a loan-to-value ratio of 80 percent. At that point, the borrower may initiate the process of canceling PMI premiums from that point forward. Lenders are required to cancel PMI automatically when that ratio hits 78 percent, notes Bankrate.