What is Private Mortgage Insurance?

Written by: Christy Rakoczy

What is Private Mortgage Insurance?

Keywords: PMI, Private Mortgage Insurance, Mortgage

Private mortgage insurance, or PMI, is an insurance policy that home buyers are required to purchase in certain cases when getting a mortgage for a home.  Unlike standard insurance policies that protect you from financial loss, PMI is an insurance policy designed to protect the bank in case you default on the mortgage.  The cost of PMI is normally set as a percentage of the mortgage balance and can be an expensive addition to your monthly mortgage bill.

When Is PMI Required?

PMI is required when you purchase a home and put down less than a 20 percent down payment.  In other words, if you buy a home worth $100,000 and you put down less than $20,000 on the home, you will be required to purchase private mortgage insurance by your bank.

You may be able to avoid paying for PMI if you can structure your mortgage into two separate loans as opposed to a single loan for more than 80 percent of the value of your home.  For instance, if you purchased a $100,000 home and only put down $10,000, you would technically have to pay PMI if you borrowed $90,000 in a single loan.

To avoid PMI, you might choose instead to borrow $80,000 in a first mortgage and $10,000 in a second mortgage.  This is commonly referred to as an 80-10 loan.  80-20 loans are also a possibility and involve putting down nothing, but these have become very difficult if not impossible to qualify for.  Even 80-10 loans are now more difficult to obtain due to tougher regulations in the mortgage market, but they are still available for people with excellent credit.

Why is PMI Required

PMI is required to protect the bank or mortgage lender from potential loss.  When you purchase a home, you are supposed to have some of your own money invested in that home.  This is referred to as owner’s equity.  When you have your own money in your home, this protects the bank in several important ways.  First, if property values decline, the value of the home (the collateral for the loan) is less likely to dip below the amount that you owe, resulting in you being underwater on the mortgage.  Second, when you have your own money invested, you are less likely to simply walk away from the mortgage and leave the bank holding the bag if property values do go down.

Because owner’s equity is important for the lender’s protection in making the loan, PMI is required when you do not have such equity.  PMI insures the loan and the bank is paid in the event of a default.  It does not protect you as the borrower; you still have to make payments and you can still be subject to a foreclosure action if you do not pay.  Despite the fact that PMI protects only the lender and not the borrower, the borrower is still the one who needs to pay for the cost of the insurance.

How Much Does PMI Cost?

The cost of PMI is typically set at a percentage of the total amount borrowed. This percentage is between .5 percent and 1 percent of the entire loan amount annually.  Because the cost is quite significant, it is best to avoid PMI whenever possible by saving an adequate down payment before buying a home.


LIKE US ON FACEBOOK   

What is Private Mortgage Insurance?

Share Tweet Pin It