What is Private Mortgage Insurance (PMI) and How It Works

Did you know that the seller can pay your private mortgage insurance (PMI?

Private mortgage insurance graphic Conventional home loans underwritten to the lending guidelines (rules) of the Federal Home Loan Corporation (aka Freddie Mac) and the
Federal National Mortgage Association (also known as Fannie Mae) require a 20% down payment.

But of course, most borrowers are unable to provide a 20% down payment. Fannie Mae and Freddie Mac need the 20% equity as a buffer in the event of a foreclosure. If the borrower defaults on the loan, the property can be sold for 20% below the home's value.

Private mortgage insurance (PMI) companies pay the lender the difference between your down payment and the required 20% down payment if you default on the loan.

For example, if your down payment is 5%, the PMI company will pay the lender 15% of the sales price if you default on the mortgage. Between your 5% and the PMI company's of 15%, the lender has 20% equity in the property and a cushion if there is a foreclosure.

The cost of the private mortgage insurance is paid by the borrower of course. There are four payment options with private mortgage insurance. The PMI cost takes into consideration an applicant's credit score, down payment amount, several other variables.

Borrower-paid mortgage insurance (monthly)
Single-premium mortgage insurance
Split-premium mortgage insurance
Lender-paid mortgage insurance

Borrower-paid mortgage insurance (monthly)

Without question, the most popular payment plan is the monthly mortgage insurance option. Probably because it's the easiest for the loan officer. The PMI premium is billed annually and the lender collects 1/12 of the annual premium and includes the cost with the mortgage payment.

Single-premium mortgage insurance

Rather than splitting the PMI payments into monthly installments, single-premium PMI combines the full cost of the insurance into a single payment.

You can either pay the full amount at closing or roll the amount into the loan for a higher loan balance, depending on the loan terms. This option can be used in conjunction with seller paid assistance.

Split-premium mortgage insurance

The split-premium mortgage insurance blends the monthly mortgage insurance premium with the single-premium mortgage insurance. There is an upfront payment at closing and a reduced monthly payment.

Lender-paid mortgage insurance

The lender-paid mortgage insurance reminds me of the shell game. With lender paid mortgage insurance, you agree to a higher interest rate in exchange for removing the private mortgage insurance altogether.

Here's a comparison between the 4 PMI options:

The following example assumes a credit score of 680 with a down payment of 10%:

Monthly - $108.33
Split-premium mortgage insurance - $2,000 (1%) paid at settlement & $78 monthly
Single-premium mortgage insurance - $3,317
Lender-paid mortgage insurance - Mortgage payment increases by $83

There is one more option. A bit confusing, so I won't get into a long explanation, but it involves using a second mortgage to off set the private mortgage insurance expense. This option is usually called a piggy back loan, because the 2nd mortgage piggybacks the 1st mortgage.

Using the previous example, the
sales price is $222,222
less $22,222 (10% down payment)
2nd mortgage 22,222 @8% = $146 monthly

The 2nd mortgage can be a fixed rate, or an adjustable interest rate.

When does private mortgage insurance end?

The federal Homeowners Protection Act (HPA) allows for the elimination of Private Mortgage Insurance (PMI).

Generally, the law offers two methods for removing PMI from a house loan:
(1) seeking PMI cancellation; or
(2) terminating PMI automatically or permanently.

Request cancellation of PMI

If the outstanding balance of your mortgage is less than 80% of the home's original value, you have the right to request that your servicer cancel the private mortgage insurance. This cancellation date should have been disclosed to you in writing during the mortgage application, with the PMI disclosure form. Contact your service provider if you can't find the disclosure form.

You may be eligible for PMI cancellation sooner, if you have made additional payments that reduce the principal balance of your mortgage to 80 percent of the home's original value.

The term "original value" refers to the lesser of the contract sales price or the appraised value of the property at the time of purchase (or, if you have refinanced, the appraised value at the time you refinanced).

Additional conditions must be satisfied if you want to eliminate the PMI on your loan:

If the value of your property has fallen below the initial purchase price, you may be unable to cancel PMI at this time.
You must have a positive payment history and maintain current payments.
You must submit your request in writing.
Your lender may ask you to produce proof (such as an appraisal) that the value of your property has not decreased below the home's original worth.
Your lender may ask you to confirm that there are no junior liens on your property (such as a second mortgage).

Termination of PMI automatically

Even if you do not request that your servicer discontinue PMI, your servicer is required to do so automatically when your principal amount reaches 78 percent of the home's original value.

To ensure that your PMI is terminated on that date, you must be current on your payments at the time of the expected termination. Otherwise, PMI will remain in effect until your payments are brought current.

SOURCE: Consumer Financial Protection Bureau

Conclusion

In conclusion, whether or not PMI is required for a conventional mortgage depends on a variety of factors. It is important to speak with a qualified mortgage professional to determine if PMI is necessary for your specific situation.