Do conventional loans require private mortgage insurance?

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 private 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 private 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 private 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 private 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

Conclusion

In conclusion, conventional loans require PMI when the down payment is less than 20%. This protects the lender in case of default. Borrowers can avoid PMI by making a down payment of 20% or more.

SOURCE:
Consumer Financial Protection Bureau
Termination of Conventional Mortgage Insurance
Mortgage Insurance Coverage Requirements