Understanding PMI

First-time homebuyers might be surprised to learn that your monthly mortgage payment is more than the amount due on your home loan.

That's what's called the principal; the payment also includes interest, taxes and something else: private mortgage insurance, or PMI. Understanding how PMI works is an important part of any homebuying experience.

WHAT IS IT?

PMI is an additional fee that lenders attach to conventional loans as a safeguard. Established in 1998 by the Homeowner's Protect Act, private mortgage insurance is designed to encourage banks to lend to those with smaller down payments or fewer resources for mortgage payments, since it protects them from borrower default. Lenders have less risk, and buyers in turn have more choice in buying a new home.

DO YOU NEED PMI?

PMI is provided by individual outside companies, and arranged for by your chosen lender. It's typically required when you make a down payment of less than 20 percent of the total home purchase price. PMI is also usually needed if you refinance with a conventional loan, but have less than 20 percent of the value of your home in equity.

HOW DO I PAY?

Your PMI premium is most commonly paid as part of your regular monthly mortgage obligation. Details about it can be found under the closing disclosure heading in the projected payments section of your loan documents. Loan estimates distributed before you sign the mortgage will detail the amount. Some lenders offer different payment options, however, so ask if there are other choices available. For example, PMI can sometimes be paid as an up-front one-time premium at your closing. Just be aware that you may not receive a refund on this premium in certain instances if you refinance or move.

CAN I AVOID PMI?

Anyone who applies a down payment of more than 20 percent and agrees to carry a loan balance for the rest can choose to waive PMI coverage. Those with PMI can sometimes set a date of termination with their lender, after which the policy will be canceled — as long as mortgage payments have been consistently made. Recently, it's become more difficult to receive a PMI termination without some sort of refinancing, so review your agreement before signing. You may also no longer need PMI coverage if the value of your home has significantly increased.