What is PMI?
PMI, or private mortgage insurance, can come in several different varieties. And while borrowers often think of PMI as a negative, it does serve a very important purpose. That is, it allows homebuyers to purchase a house without needing a 20% down payment.
Prior to the resurgence of PMI in the 1950’s, homebuyers needed to make a downpayment of at least 20%. This was difficult for many young home buyers, especially those purchasing their first home. PMI allowed lenders to offer loans of greater than 80% without the risk of significant losses from foreclosure. PMI insures a specific portion of the loan amount, generally between 12-30%, depending on the down payment percentage. The lower the down payment, the higher the percentage covered by PMI. Lenders can make a claim in the event of a loss from foreclosure of up to the insured amount. This, ironically, actually makes a low down payment loan a lower risk than the traditional 20% down loan.
Generally, once a homeowner has paid the principal balance of the mortgage down to 78% of the original value of the house (or purchase price, in the case of a purchase), the PMI is automatically cancelled. There are some exceptions to this rule, including properties in New York, second homes, investment properties, etc. For specific information as to when PMI will be cancelled on your loan, contact one of our mortgage professionals.
PMI can be paid in several different ways:
- Borrower Paid Monthly – This is the most common form of PMI. An annual rate is set by the mortgage insurance company, and used to determine an monthly amount, which is added into the mortgage payment. The lender collects the payment, but it is then paid to the mortgage insurance company.
- Lender Paid – While less common, this can sometimes be a smart way for PMI to be paid. The lender will purchase a policy from the mortgage insurance company and pay for the entire policy in a single payment. The cost for this is passed along to the borrower, generally in the form of a slightly higher mortgage rate. The benefit of this is a slightly lower monthly payment than if the PMI was paid monthly and included in the payment. The downside to this option is that since the trade-off is a higher rate, that higher rate stays for the life of the loan, unlike PMI, which eventually goes away.
- Single Premium – This is very similar to lender paid, but the borrower makes the lump sum upfront payment. This prevents the rate from being increased, but does increase the amount of money needed at close.
No matter which option you choose, they all allow you to buy a home without the need for a large down payment. This can either allow you to buy a home much sooner, since you do not need to save as much money, or allow you to buy a more expensive home. A $100,000 home with a 20% down payment and a $200,000 home with a 10% down payment both require the same amount of saved money.
There are other loan programs available that have similar insurances. And while they are often confused as being the same as PMI, they are not.
FHA loans have MIP, or mortgage insurance premium. While similar in some ways, allowing a buyer to finance more than 80% of the purchase price, MIP is paid directly to FHA, not a mortgage insurance company. FHA self-insures the loans they guarantee. They collect both an upfront fee (UFMIP), and a monthly fee (MIP). The UFMIP is financed into the loan, so the borrower does not need to pay it out-of-pocket at the time of close. Both the upfront and monthly fees are collected and put into a fund, that covers FHA’s losses in the event that a lender places a claim in the event of foreclosure.
One benefit to FHA MIP is that the percentage the borrower pays is flat, meaning it is not dependent on credit. PMI can get prohibitively expensive for a borrower with less than stellar credit. Unfortunately, unlike PMI, MIP stays on the loan for the life of the loan, and is required regardless of down payment.
Similar to FHA, USDA collects mortgage insurance to self-insure and guarantee loans. They collect a guarantee fee upfront, and a monthly mortgage insurance fee. Also like FHA, the monthly fee exists for the duration of the loan, and is required regardless of down payment.
For qualified veterans, the VA collects only a funding fee at the beginning of the loan. Unlike other loan programs requiring mortgage insurance, there is no monthly fee. This can dramatically reduce the monthly payment required. The amount of the funding fee varies based on the type of military service, whether or not the VA eligibility has been used prior, and if the veteran is disabled. To find out what your funding fee would be, contact one of our mortgage specialists.