What is Private Mortgage Insurance(PMI)?

If you make a down payment of less than 20% of the purchase price of the home, mortgage lenders generally require that you take out Private Mortgage Insurance (PMI) that protects the lender in case you default on your mortgage. You may need to pay up to a year’s worth of premium for this coverage at closing.

How does Private Mortgage Insurance work?

PMI companies write insurance protecting approximately the top 20% of the mortgage against default, depending on the lender’s and investor’s requirements, the loan-to-value ratio, and the particular loan program involved. Should a default occur, the lender sells the property to liquidate the debt, and is reimbursed by the company for any remaining amount up to the policy value.

Could obtaining Private Mortgage Insurance help me qualify for a larger loan?

Yes. Let’s say that you are a family with $42,000 annual gross income and monthly revolving debts of $800 (car payment and credit cards) and have $10,000 for a down payment and closing costs on a mortgage at 7% interest. Without PMI, the maximum price you can afford is $44,600. But with PMI covering the lender’s risk, you can buy a house worth $62,300. That’s 39% more house!

What does Private Mortgage Insurance cost?

Costs vary from insurer to insurer, as well as from plan to plan.

How is Private Mortgage Insurance paid?

PMI fees can be paid in several ways depending on company used. 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 at closing but not increase their monthly house payment can finance a lump-sum PMI premium into their loan. With this type of payment plan, should the PMI be canceled before the loan term expires (through refinancing, paying off the loan, or removal by the loan servicer), the buyers may obtain the rebate of the premium.

How does the buyer apply for Private Mortgage Insurance?

Although the buyer typically bears the cost of PMI, the lender is the company’s client, and shops for the insurance on behalf of the borrower. Many lenders deal with only a few PMI companies because they know the guidelines for those insurers. This can be a problem when one of the lender’s prime companies turns down a loan because the borrower doesn’t fit its risk parameters. An un-enterprising lender might follow suit and deny approval on the loan application without consulting even a second company. This obviously could leave all the parties involved in an undesirable position.

The lender has an increasingly difficult task to be fair to the borrower while shopping for the most effective method to soften liability. Sometimes, it may appear that a lender has no justification for doing what he or she does – but if we look deeper, it is undoubtedly there.

Cancellation of Private Mortgage Insurance

The Homeowners Protection Act of 1998 – which took effect in 1999 – 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. These 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 – 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 insurance also can be canceled at your request (with certain exceptions) when you reach 20 percent equity in your home based on the original property value, if your mortgage payments are current.

One exception is if your loan is “high-risk.” Another is if you have not been current on your payments within the year prior to the time for termination or cancellation. A third is if you have other liens on your property. For these loans, your PMI may continue. Ask your lender or mortgage servicer (a company that collects your payments) for more information about these requirements.

If you signed your mortgage before July 29, 1999, you can ask to have insurance canceled once you exceed 20 percent equity in your home. But federal law does not require your lender or mortgage servicer to cancel the insurance.

History of Private Mortgage Insurance

Private Mortgage Insurance originated in the 1950s with the first large carrier, Mortgage Guaranty Insurance Corporation (MGIC), referred to as “magic”. For this reason, early Private Mortgage Insurance methods were described as “magically” assisting borrowers in getting lender approval on an otherwise unacceptable loan package.

Rob Tennyson