What is mortgage insurance (also known as PMI) and when is it required?

Mortgage insurance - sometimes referred to as private mortgage insurance - is provided by a private company to protect the mortgage lender against losses that might be incurred if a borrower defaults on mortgage payments. It is most often required if the loan amount is more than 80% of the home's value.

Mortgage insurance makes it possible for a borrower to buy a home with less than a 20% down payment. It protects the lender against the additional risk associated with low down payment lending, which is becoming more popular. When borrowers purchase mortgage insurance, lenders are often comfortable with down payments as low as 3-5% of the home's value. Mortgage insurance also gives the borrower the option to buy a more expensive home than might be possible if a 20% down payment were required.

The mortgage insurance premium is based on loan-to-value ratio, type of loan, credit score and amount of coverage required by the lender. Usually, the premium is included in your monthly mortgage payment, and one month of the premium is collected as a required advance at closing.

Private mortgage insurance can be cancelled at some point, such as when your loan balance is reduced to a certain amount - below 75% to 80% of the property value. Recent federal legislation requires automatic termination of mortgage insurance for many borrowers when their loan balance has been amortized down to 78% of the original property value.

Mortgage insurance should not be confused with mortgage life insurance, which is designed to pay off a mortgage in the event of a borrower's death.