If you buy the home and make a down payment of, say, 20 percent of the purchase price, the lender is putting up the other 80 percent of the purchase price. So if the home burns to the ground and is a total loss, the lender may care more, at least financially, than you do. In most states, your home is the lender's security for the loan.
- Almost all lenders today require you to purchase private mortgage insurance (PMI) if you put down less than 20 percent of the purchase price when you buy.
- Some lenders, in years past, learned the hard way that some homeowners may not care about losing their homes. In some cases, where homes were total losses, homeowners with little financial stake in the property and insufficient insurance coverage simply walked away from the problem and left the lender with the financial mess.
- Although PMI typically adds several hundred dollars annually to the cost of your loan, it protects the lender financially if you default. You can also expect worse loan terms such as higher up-front fees and/or a higher ongoing interest rate on a mortgage when you make a down payment of less than 20 percent.
- PMI is not a permanent cost. Your need for PMI vanishes when you can prove that you have at least 20 percent equity (home value minus loan balance outstanding) in the property. The 20 percent can come from loan paydown, appreciation, improvements that enhance the value of the property, or any combination thereof. Note also that, to remove PMI, most mortgage lenders require that an appraisal be done -- at your expense.