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WHAT IS PRIVATE MORTGAGE INSURANCE (PMI)?
Private mortgage insurance, also known as PMI, protects a mortgage lender (such as a bank or credit union) from a loss in the event you default on your mortgage loan. Lenders purchase individual mortgage insurance policies for homeowners with loans for more than 80% of the value of their homes. The cost of the mortgage insurance premiums is then passed onto the borrower and added to their mortgage payment. Once 20% of the principal balance of a loan is paid off, or a borrower owns 20% of the equity of their home, borrowers are no longer considered a high default risk and can request that the mortgage insurance policy be cancelled. By law, mortgage lenders must cancel a mortgage insurance policy once a borrower has paid 22% of the balance of the
MORTGAGE INSURANCE BASICS
Most homeowners require a mortgage to purchase a home, but not every buyer is required to insure their purchase. Private lending institutions that offer mortgages use PMI to protect themselves from a loss in the event a borrower defaults on their loan. Generally, any mortgage with a loan-to-value ratio (LTV ratio) of 80% to 97% will require mortgage insurance. That means if a borrower can only make a down payment between 3% and 20% of the value of a home, their lender will require them to have a policy. The cost of the PMI premiums for the policy are then passed on to the respective borrower and included in their mortgage payment along with the principal, interest, homeowners insurance and property taxes.
Depending on your circumstances, your bank or mortgage lender may supply your private mortgage insurance itself, source it from another financial institution, or look to the Federal Housing Administration or the U.S. Department of Veteran Affairs.
The Federal Housing Administration (FHA), in an effort to qualify more people for home loans, provides mortgage insurance to approved lenders that offer mortgages to qualified borrowers. The policies function exactly like private mortgage insurance, except a government administration, not a private company, is selling the policy. Borrowers who qualify for the FHA insurance are still responsible for the cost of their mortgage insurance premiums.
The U.S. Department of Veteran Affairs also offers something like mortgage insurance to veterans. The department guarantees a portion of home loans obtained by eligible veterans to protect private lenders from incurring losses. The guarantee allows lenders to offer favorable loan terms to veterans, including no required down payment and no required mortgage insurance.
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