What Is PMI or Mortgage Insurance

PMI or private mortgage insurance is an insurance policy and premium payment that mortgage lenders require from most home buyers who obtain home loans that are more than 80 percent of their home’s value.  In other words, buyers with less than a 20 percent down payment are normally required to pay mortgage insurance or PMI.  PMI protects a portion of the mortgage lenders loss in case the borrower defaults on the mortgage.  Should a default occur, the lender sells the property to liquidate the debt, and is reimbursed by the PMI company for any remaining amount up to the policy value.

A borrower may need to pay up to a year’s worth of premium for this coverage at closing, which can amount to as much as several hundred dollars.  PMI is protection only for the lender but its advantage is that by displacing part of the risk, a lender accepts mortgage loans with less than 20% down payment.  One obvious way to avoid this extra cost is to make a 20% down payment.  There are also other ways to eliminate PMI such as piggy back loans such as; 80-10-10 financing.  With a piggy back loan, the borrower takes out a first mortgage for 80% of the properties value and a second mortgage for 10% with 10% of the their own funds.  If possible, a piggy back loan can be a first mortgage of 80% LTV and a second for 20%, for a total 100% financing.

Costs vary from mortgage insurer to mortgage insurer, as well as from plan to plan, depending on the loan-to-value ratio, and the particular mortgage loan program involved.  For example, a highly leveraged adjustable rate mortgage would require the borrower to pay a higher premium to obtain coverage.  Buyers with 5% down payment can expect to pay a higher premium than a borrower with a 10% down payment.  Buyers on adjustable rate mortgage generally pay higher premiums than fixed rate mortgages.

The Homeowners Protection Act of 1998 establishes rules for automatic termination and borrower cancellation of PMI on home mortgages.  These protections apply to certain home mortgages signed on or after July 29, 1999 for the purchase, initial construction, or refinance of a single-family home.  The protections do not apply to government-insured FHA or VA loans or to loans with lender-paid PMI.  For home mortgages signed on or after July 29, 1999, your PMI must, with certain exceptions, must be terminated automatically when you reach 22 percent equity in your home based on the original property value, if your mortgage payments are current.  Your PMI also can be canceled, when you request, with certain exceptions, when you reach 20 percent home equity in your home based on the original property value, if your mortgage payments are current.

PMI fees can be paid in several ways, depending on the mortgage lender and mortgage insurance company used.  Home loan borrowers can choose to pay the first-year premium at closing; then an annual renewal premium is collected monthly as part of the house payment.  Or the borrower can choose to pay no premium at closing, but add on a slightly higher premium monthly to the principal, interest, tax, and insurance payment.  Buyers who want to sidestep paying PMI as a separate payment can use lender paid PMI.  In this case the lender raises the interest rate on the loan to absorb the cost of the PMI and no separate payment is passed to the borrower.

Either way it is paid, mortgage insurance is an added cost for obtaining a home loan when the loan amount is greater than 80% of the value of the home.  The mortgage insurance is a cost that can adversely impact the budget to buy a home or the budget for mortgage refinancing if not measured and evaluated in advance.  To understand all the costs of obtaining a new home and home loan with less than 20% down payment or a refinance above 80% loan to value it is imperative to know what and how mortgage insurance functions.