Private Mortgage Insurance (PMI)
History of PMI
Private Mortgage Insurance originated in the 1950’s. Traditionally, before PMI came about, borrowers were obligated to produce a minimum down payment of 20% in order to obtain a mortgage. In fact, in many cases, borrowers were required to make a down payment of 50% in order to obtain any financing. As lending guidelines became increasingly standardized, down payment restrictions loosened. However, low down payment loans were reserved for borrowers with perfect credit and income situations. With the advent of PMI, lenders were able to mitigate some of the risks of lending and therefore were able to offer low down payment loans to the masses. Although, PMI gets a ‘bad rap’ most of the time you hear it referenced, the fact is that without PMI the majority of borrowers in the United States would not be able to obtain financing at all. Additionally, Congressional legislation has also recognized the tremendous value of PMI by making it tax deductible for most borrowers.
What is 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, which can amount to as much as a several hundred dollars. One obvious way to avoid this extra cost is to make a 20% down payment.
How does PMI work?
PMI companies write insurance protecting approximately 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 PMI company for any remaining amount up to the policy value.
Could obtaining PMI help me qualify for a larger loan?
Yes, because the lender is not assuming all the risk associated with your mortgage loan, they may be more inclined to offer a larger loan amount than they would on a loan with no PMI coverage.
What does PMI cost?
Costs vary from insurer to insurer, as well as from plan to plan. 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 premium of approximately 0.78% times the annual loan amount ($92.67 monthly for a $150,000 purchase price). But the PMI premium would drop to around 0.52% times the annual loan amount ($58.50 monthly) if a 10% down payment was made on the loan.
How is PMI paid?
PMI fees can be paid in several ways, depending on the PMI 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 PMI?
Although the buyer typically bears the cost of PMI, the lender is the PMI company’s client, and shops for the PMI on behalf of the borrower. Many lenders deal with only a few PMI companies because they know the guidelines for those insurers.
Cancellation of PMI
The Homeowners Protection Act of 1998 - which became effective 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 and if your mortgage payments are current. Your PMI also can be canceled, if you can demonstrate - with certain exceptions - that you have reached 20 percent equity in your home based on the original property value and 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 (the 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 the PMI 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
