Most lenders require mortgage insurance if the homeowner has a down payment that is less than 20% of the appraised value of their home. Also known as private mortgage insurance, or PMI, this is a safety measure for the lender in the case of default. For the mortgage company, statistics and experience show that the less a borrower has invested in the house, the greater the possibility of default. So they use PMI as a precaution and a way to recoup their losses in the event the worst should happen.

The benefits:

• Less money down. In some cases, customers can put as little as 3-5% down.
• Increased buying power. With PMI customers can afford a larger loan because it gives them more leverage: for instance, $10,000 will constitute a 20% down payment on a $50,000 house (without PMI), but a 5% payment on a $200,000 house (with PMI).
• A shorter wait for a more expensive house. A 20% down payment for a $100,000 house is $20,000; a lot of money to save before being able to purchase your home. With PMI, that dream is realized much faster.

Cautions:

• PMI is relatively expensive, and cancellation is tricky at best.
• Some insurance plans have clauses and stipulations that are very specific in order to qualify, and not all of the agents are knowledgeable about them. Bottom line: you do not want to be paying for an insurance policy that you do not qualify for. Be sure to look into any and all qualifying conditions.
• According to the Home Owner's Protection Act of 1999, lenders must automatically cancel the PMI as soon as the loan-to-value ration reaches 78%. Make sure you track your payments so that you will know when this point comes, to ensure that it is cancelled in a timely fashion.
• Mortgage premiums are not tax deductible like mortgage interest payments. In some cases, you can avoid PMI by taking out two mortgages. This is called an "80-10-10" loan, where the down payment is 10%, and the loans add up to the remaining 90%.

PMI should not be confused with other mortgage insurance policies such as life or hazard, where the remaining balance on the loan is paid in the case of death or natural disaster. PMI is independent, nongovernmental insurance with the sole purpose of protecting the lender against default. The lender will usually supply the homeowner with information on various companies, and the customer chooses one and then pays the premium in monthly or annual installments. The first of these payments is collected upon closing.