A Guide to Understanding Private Mortgage Insurance

If you’re itching to buy that new home, but don’t have a 20 percent down payment saved, PMI is ready to come to the rescue – for a price.
Private mortgage insurance, or PMI, is a policy required by lenders on conventional mortgage loans when the mortgage amount will exceed 80 percent of the value of the property. Government sponsored mortgage programs such as Federal Housing Administration loans also require mortgage insurance. The policy protects lenders in the event of default on a loan. It’s known as “default insurance” in that it reduces the risk of loss for the lender when the borrower puts less than 20 percent down on the purchase of a property. If the property goes into foreclosure and there is a balance due after the sale of the property, the lender would file an insurance claim to the PMI company.
What’s the cost of PMI to a borrower? A borrower with a good credit history purchases a home for $150,000 with 5 percent down. The mortgage amount would be $142,500. A lender would typically require PMI with 25 percent coverage, which carries a premium currently of 0.67 percent annually or $954.75 per year, which would add $79.56 to the regular monthly mortgage payment.
PMI costs vary according to the amount of coverage the lender requires, which is based on the risk factors associated with the mortgage. These factors include the amount of down payment, the borrower’s credit history, the type of loan documentation, and the mortgage loan type (fixed rate vs. adjustable rate mortgage, for example).
PMI premiums are regulated by federal and state insurance boards and typically do not vary among insurers. However, the amount of coverage required and, therefore, the cost of the insurance may vary among lenders depending upon the analysis of the risk. Lenders may offer different options for paying for PMI, including a lump sum at closing.
Some lenders advertise that they “self-insure” and don’t require PMI. But all the lender is doing is increasing the interest rate on the loan to the same level that paying the insurance premium would add. This option can be beneficial in that it entitles borrowers to a higher interest deduction on their tax return.
If you haven’t saved enough for the 20 percent minimum down payment, there are only a handful of ways you can avoid PMI. You can borrow against your 401K plan for the down payment without incurring a penalty. Or, you can obtain an 80 percent first mortgage and up to a 20 percent second loan.
Often known as a piggyback mortgage, this second loan finances the difference between the down payment and the cost of the house. It in effect allows 100 percent financing, but requires different terms (both rate and amortization periods) than the first mortgage.