Private mortgage insurance. You may or may not have heard of the term, but it’s likely you’ve heard its acronym, PMI, especially if you’re preparing to buy a home and deciding how much to put down on your purchase and how much to borrow. But what exactly is PMI? Who needs it and why?
Fannie Mae and Freddie Mac long ago started requiring a private mortgage insurance policy on certain loans. Let’s first look at where PMI originally came from and the need it filled.
The federal government began insuring mortgages with the introduction of the FHA loan back in 1934. FHA loans required substantially less down compared to what local banks were able to offer. Back then in order to get financing for a home, the borrowers typically had to provide down payment amounts as high as 50 percent. That kept most people from buying a home.
The FHA loan then allowed a down payment of 10 percent, if the borrower purchased a mortgage insurance policy from FHA. This insurance policy compensated lenders when borrowers defaulted on their FHA loan.
Soon after the introduction of the FHA program, Fannie Mae came along. Yet Fannie Mae loans required a minimum down payment of 20 percent.
In 1956, a private company came up with the idea to create an FHA-like insurance policy that would compensate lenders who issued Fannie Mae type loans with less than 20% down.
Basically, since this mortgage insurance was provided by a private company, it came to be known as private mortgage insurance, or PMI, as opposed to a government sponsored insurance program like FHA.
Private Mortgage Insurance Rates
How much is private mortgage insurance? Different borrower characteristics can affect the premium amount for mortgage insurance including whether or not the borrower is a first time buyer. Credit scores are involved as well the amount of down payment.
As an example, let’s take a look at two scenarios, both for a 30 year fixed loan on a purchase price of $250,000:
- A buyer with a credit score of 640 and down payment of 10 percent
- A buyer with a credit score of 770 and down payment of 10 percent
The 640 borrower would pay $142.50 per month in mortgage insurance, and the 770 borrower would pay only $82.50 per month.*
This is where you can really cash in if you are a high credit borrower. Unlike FHA, private mortgage insurance is risk-based. The lower the risk you are, the lower premiums you’ll pay, just like with auto insurance.
With an FHA loan, both of these borrowers would pay $243.75 per month in mortgage insurance. See our in-depth analysis of FHA versus PMI.
If you have good credit and a down payment of at least 5%, you may want to consider private mortgage insurance.
How Do I Request PMI?
Your loan officer will order PMI for you as part of the loan process. It’s not a policy you need to obtain on your own.
Many companies offer PMI, such as Radian, RMIC, MGIC, and others. Ask your loan officer to shop around for the best policy for you, since each PMI company offers higher or lower rates for different scenarios.
Different Types of PMI
There are different ways to pay for PMI. You can make monthly payments, which is the most common way to pay. You can also make a lump sum premium up front, called borrower-paid mortgage insurance, or BPMI. Or, lender-paid PMI (LPMI) is an option, where you take a slightly higher rate in return for the lender making a one-time upfront PMI payment for you.
Not every lender offers every PMI payment type. Check with your lender to see which types of PMI it offers.
So is PMI worth it? That depends upon your perspective but generally speaking, yes, it is. The borrowers are required to have a PMI policy but in exchange they got to put less money down. Ultimately however, the PMI policy goes away. How?
Cancelling Private Mortgage Insurance
Once the mortgage balance falls to 78 percent of the original sales price of the home, mortgage insurance is required by law to terminate. Depending upon the loan term however, this gradual reduction of loan term can take several years.
If the borrower feels the current loan balance is at or below 80 percent of the current appraised value of the home, the request can be made to remove the policy. This requires an official request to the lender, who will then order an appraisal to verify the current market value. If your loan balance is in fact less than 80 percent of the new appraised value, the PMI premium may be removed.
As a comparison, most FHA loans require monthly mortgage insurance for the life of the loan.
PMI is Not Tax Deductible in 2014-2015
One final note, congress allowed PMI payments to be tax deductible from 2007 to 2013. However, the bill that enabled the deduction expired and has yet to be extended. This is disappointing, since PMI can add up to a serious tax deductions for many homeowners. But for now, don’t count on it being deductible. As with any tax issue, consult your tax adviser, as this website does not give tax advice.
When considering a conventional loan with a down payment of less than 20 percent, make sure you fully understand the PMI policy you’re about to take including different payment and financing options as well as how and when PMI can be removed.
It’s quite possible that private mortgage insurance is the best option for you. Contact us about PMI and we’ll be in touch.
*Per MGIC rate finder 8/15/13