Insurance or PMI is insurance that protects the lender in case a buyer defaults on a loan. Most lenders require PMI whenever a buyer is putting down less than 20% of the purchase price of a home and then pass the cost
on to the borrower.
PMI does not, as some people believe, provide protection for a buyer, such as paying off the mortgage balance in the case of death, disability or unemployment. PMI is required by lenders in most
cases where the buyer's equity position is less than 20% of the home's value, because the less equity a buyer has in a home, the more risk there is that s/he may default on the mortgage.
If PMI protects only the
lender, how does it benefit the buyer? The most important benefit of PMI is that it opens the door to homeownership for many buyers, enabling them to buy a home sooner (often by several years) than they otherwise could,
because they don't have to wait until they save a 20% down payment. Even buyers who can afford a 20% down payment may opt to put a smaller amount down - usually for tax or investment reasons.
In the past, PMI premiums
were fairly consistent, ranging from .005% to .0025% of the loan amount per month depending on the level of equity the borrower had in the home. Recently, PMI insurers made a beneficial change providing an alternative
to the large up-front premium that borrowers traditionally paid when the loan closed. Now, borrowers have the option of paying an up-front fee or paying a slightly higher monthly premium.
A few lenders - Prudential
Home Mortgage is one of the most prominent - offer buyers an alternative to PMI. Basically, the lender self-insures, offering a loan to the buyer at a slightly higher rate, which compensates the lender for added risk of
a low down payment loan. Going with the lender who self-insures has two advantages: First, PMI companies sometimes turn down borrowers who lenders have already approved. With a self-insuring lender, this risk is
eliminated. Also, the extra interest paid may be tax deductible, unlike PMI payments, which are not.
There are three main types of mortgage insurance:
Veterans Administration (VA)...
loans are available to military veterans and certain other government workers for a 1% fee. If you qualify, you can get a loan with no money down. However, lenders are unlikely to make very large loans since they are
guaranteed reimbursement only up to $36,000.
To apply for a VA loan, you need a "Certificate of Eligibility", available from the local VA office. For more information, contact the VA office in the Federal
Government listings in your phone book.
Federal Housing Administration (FHA)...
Under FHA insurance, anyone can obtain financing with less than 5% down. This is an attractive proposition for first time home
buyers. If you are interested in this option, check with your lender. Some lenders will not work with FHA loans because of the tremendous paperwork required by the government.
The maximum loan amounts FHA insurance
will cover are geared to the prevailing values in an area but typically do not exceed $125,000. Borrowers must pay a one-time insurance premium of 3.8% of the loan total. This can be paid at closing or added to the
amount of the loan.
Private Mortgage Insurance (PMI)...
Borrowers can get a loan with as little as 5% down through PMI. There is no limit on the amount of the mortgage.
The premium varies from .3% to 1.2%
at settlement and .3% to .55% a year thereafter. The rate depends on the size of the down payment and the type of mortgage. The more you put down, the lower the premium. The change is lower for a fixed rate mortgage
than for an adjustable rate mortgage. As an alternative to paying monthly premiums, you can pay the entire fee in a lump sum payment. This amount can also be financed.
Once the amount due on your loan has dropped
below 80% of the purchase price or appraised value (whichever is less), you no longer pay premiums. You must tell your lender and insurance provider this has occurred. They do not automatically stop requiring payments.
Your loan officer can provide additional information about private mortgage insurance.
Latest Breaking News! PMI will now be dropped automatically
by your lender, but do check with your loan agent, once your home equity reaches 20% of its fair market value.