Q. What is Private Mortgage Insurance and why do I need It?
A. PMI is an acronym for private mortgage insurance also referred to as simply mortgage insurance. PMI is a type of insurance that covers the lender on the event you default on the loan. It is generally required on loans that have high LTV’s or low down payments. Mortgage lenders will normally require private mortgage insurance on home loans that have a loan to value greater than 80%. The loan to value or LTV is measured by taking the loan amount divided by the property value or for a purchase it can also be measured by taking 100% minus the percentage of the down payment. For example a home loan purchase with 10% down payment has a loan to value of 90% or a home loan that is for $75,000.00 on a home that is appraised at $100,000.00 has a 75% loan to value.
The private mortgage insurance covers the mortgage lender but will have top be paid by the home loan borrower as part of their monthly mortgage payment. Private mortgage insurance was established to help home buyers that had less than 20% for down payment. The insurance company absorbs a portion of mortgage lenders losses in the case of default and foreclosure for those home loans with private mortgage insurance that have less than 20% down. Without the added insurance, the mortgage lender would not make the home loan unless the down payment was at 20% or greater.
The private mortgage insurance cost is a reflection of the mortgage loan amount, the type of mortgage loan and the loan to value. The higher the loan amount is relative to the home’s value or the LTV, the greater the private mortgage insurance cost will be. This may seem fairly obvious, the less equity in the home the more the risk to the mortgage lender and therefore the higher the insurance costs.
Higher private mortgage insurance costs due to larger loan amounts is not necessarily a measure of risk but simply a higher cost since private mortgage insurance is priced as a percentage of the mortgage loan amount.
The mortgage loan type can change the private mortgage insurance costs since some home loans have a slightly higher risk of default. The best example for this is adjustable rate mortgages. A higher loan to value, low down payment, adjustable rate mortgage is more risky than a 30 year fixed rate mortgage loan and therefore has a higher private mortgage insurance cost.
Two avoid private mortgage insurance you have to have a 20% equity in the property. Either 20% or more for a down payment on a purchase or for a refinance, the loan to value can not exceed 80%. Stated another way, the new home loan can not exceed 80% of the property value for either an existing mortgage refinance or home purchase.
Some mortgage lenders allow customers to put down less than 20% to avoid PMI by taking two mortgage loans. This is accomplished by obtaining a first mortgage for 80% of the property’s value and a second mortgage loan for 10% of the property’s value. This is commonly referred to as 80-10-10 loan since the first mortgage is for 80% loan to value, the second represents 10% loan to value and the third 10 represents 10% down payment from the borrower. At one point mortgage lenders also allowed 80/20’s in which the borrower obtained two mortgage loans that together were 100% of the value of the home. The 80/20 is pretty much extinct and the 80-10-10 is very difficult to find.
Mortgage insurance is usually set up as addition to the monthly mortgage payment. A standard monthly mortgage payment includes principal and interest as well as taxes and insurance. The insurance usually refers to the homeowners insurance. A loan with private mortgage insurance will have added insurance charge for the private mortgage insurance costs. A change in private mortgage pricing in the past five years set up to alleviate the tax differences between the tax deductible costs of private mortgage insurance and the interest on second mortgages is something called lender paid PMI.
In these situations the mortgage lender covers the cost of the private mortgage insurance and there is no added costs at the home loan closing or added to the monthly mortgage payment. However, the mortgage lender absorbs this added cost by raising the mortgage rate on the home loan to compensate their costs for the private mortgage insurance. This increase in the mortgage rate to cover additional costs is the same technique used in no point / no closing costs mortgage loans in which the mortgage lender raises the mortgage rate to absorb the mortgage loans’ closing costs.