Does PMI Come Out of Escrow?

Although the lender can foreclose on your home if you default on the loan payments, there's not a guarantee that the property will sell at auction. To fully protect against loss, mortgage lenders also use mortgage insurance. This is a separate policy that pays the lender in the event of default and financial loss. Even though the insurance doesn't protect you in any way, you have to pay the premiums. However, spreading out these payments can allow you to obtain a home loan with less than 20 percent down.

PMI costs are based primarily on the loan amount, down payment amount and repayment term. On average, PMI yearly premiums are less than one percent of the total loan amount. The costs vary based on lender, loan amount and original loan-to-value ratio. For example, if your total loan amount is $200,000 and your PMI rate is three-quarters of a percent, that equals $1500 per year, or $125 per month.

Failure to pay property taxes can result in a tax lien or tax foreclosure, and not paying your homeowner's insurance premium will result in losing your coverage, so your mortgage lender must also ensure that you're paying these bills on time. An escrow account is established to hold the funds for these payments, and when they are due, the lender pays them on your behalf. Each month, you pay a portion of the year's total bill -- approximately 1/12 -- in addition to the mortgage payment. Most lenders require borrowers to use an escrow account if they have less than 20 percent for a down payment.

Although PMI is an additional cost most homeowners aren't thrilled about, it's often necessary. There is good news, though -- paying PMI isn't forever. Once your loan-to-value ratio falls below 80 percent, you can request for your lender to cancel the PMI policy. Under the Homeowner's Protection Act, the PMI has to be cancelled by the lender when the balance reaches 78 percent. Typically, the same can be said about a required escrow account. Your lender might be willing to eliminate it once you've paid down the balance enough. Once it's cancelled, you'll be responsible for making the tax and insurance payments on time.