If you buy a property with less than 20 percent down, many lenders require that you also purchase private mortgage insurance (PMI). Do not confuse this with mortgage life insurance (click to see my earlier post on that topic), which you should think carefully about buying.

PMI is the promise of a private insurer to repay your lender if you default on the loan. It’s a contract between your lender and the insurance company for which you pay the premiums. And the monthly PMI premiums can make a significant difference in the amount of your total mortgage payment.

Depending on the specific terms of the PMI contract, if you default on the loan, the lender can collect 20-25 percent of the total outstanding loan from the PMI insurer and then foreclosure on the property. Or the PMI insurer can pay off the entire loan and gain title to your property. Either way, you and your family are not protected—the lender is the entity that is protected with PMI.

Most lenders that require PMI also have provisions in their contracts for when the coverage can be dropped—typically after the loan is a certain age or the loan-to-value ratio reaches a certain point.

If you are required to buy PMI coverage, understand that this will not protect you from the consequences of defaulting on your loan or pay off your loan in the event of your death or disability. Read the contract carefully and make a note to follow up and get the insurance canceled when your lender allows.

Jackie