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What is private mortgage insurance?

By: 11 September 2011 2 Comments

A lot of factors go into calculating a mortgage payment, but one over which a homebuyer has a lot of control is the amount paid toward private mortgage insurance (PMI).

What, exactly, is PMI?

Simply put, it is insurance which helps protect the lender should the buyer go into default. The idea is that money raised through PMI premiums will cover the lender’s losses should the institution have to take back a home and sell it.

Buyers can’t do a lot about how much they pay on interest and principal every month or, in many cases, how much cash is put into escrow to cover property taxes. However, they can have a considerable amount of control over how much they pay in PMI premiums.

PMI only comes into play on those mortgages that finance over 80 percent of the purchase price or fair market value of a home. Let’s say, for example, a buyer wants to purchase a home that is selling for its fair market value of $150,000. If the buyer puts $30,000 – 20 percent of the price – down and finances $120,000, then PMI is not an issue.

Why does the buyer who puts down 20 percent avoid PMI? It all has to do with risk – the chances are greater that a lender will be able to cover its losses when the buyer has 20 percent equity in the home when the mortgage is written. Also, there’s the notion that a buyer who is so heavily vested in a loan is more likely to stick with it.

If that same buyer puts down $7,500 – 5 percent of the purchase price – and borrows $142,500, then a monthly PMI payment will be added to the mortgage. How much is that payment? That gets complex – the more money a buyer puts down, the lower the PMI premium will be.

In our example, the buyer is looking at paying an annual rate of 0.78 percent of the total amount borrowed – $1,111.50 per year or $92.63 per month. The percentage used to calculate PMI drops as down payments increase. Borrowing 85 percent of the purchase price, for example, drops the annual PMI rate to 0.32 percent, thus resulting in considerably lower monthly insurance premiums.

Again, the math on calculating PMI can get somewhat complex. Thankfully, there are mortgage bankers around to help consumers figure out such things.

At any rate, people speak of the virtues of large down payments quite a bit, but generally don’t touch on the subject of lower PMI payments. It’s also worth mentioning that those payments don’t last for the duration of the loan. Once the loan-to-value ratio gets below the 80 percent range, PMI is generally no longer a factor provided the buyer has paid on time and has abided by the terms of the mortgage.

PMI can be a complex issue, but not an overly daunting one. Anyone considering taking out a mortgage ought to have a discussion about the insurance with his or her mortgage bankers to figure out what options are available to lower PMI payments or avoid them entirely.

Home Sweet Home is written by Ethan C. Nobles and is sent weekly to publications throughout the Natural State on behalf of the Mortgage Bankers Association of Arkansas.

About: Ethan C. Nobles:
Benton resident. Rogue journalist. Recovering attorney. Email = Ethan@FirstArkansasNews.net.

2 Comments »

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