Private Mortgage Insurance

Private mortgage insurance (PMI) is something people bump up against for the first time when they apply for a home loan. Unfortunately, given its inherent nature, it is quite confusing.

But, if you as a borrower understand this is insurance that protects the lender and not you the borrower, you should have no problem with the rest of its associated qualities. Lenders really only want one thing. They want a return of their principal.

Of course they want to make money but first and foremost they want some kind of guarantee they will get their loan funds (principal) back. Enter mortgage insurance as the vehicle to “insure” a return of principal.

Generally, PMI is required on loans where the borrower does not make a 20% down payment. How lenders came up with 20% as the magic number is inconsequential as it is now the standard that determines whether, or whether not, PMI is required.

PMI, in theory, enables a borrower to purchase a home with as little as 3% to 5% down. There are even some loans that don’t require anything down. Keep the 20% standard in mind because any loan without the 20% down is a candidate for PMI.

Many buyers don’t have 20% down so they would be frozen out of the market. PMI steps in and lets them buy with less than this nebulous 20%. This is a good thing.

The theory also says that because the borrower doesn’t have to put down the 20%, the borrower can use those funds, or what funds he has, to buy appliances, make repairs, let sit in a savings account or whatever. This too is a good thing.

The image of PMI changes when the borrower fails to repay the loan. This is called a default in the industry. When this happens the lender goes through a process called foreclosure and acquires title to the property.

The image of PMI changes because after the foreclosure the lender makes a claim on that insurance policy. Remember I said above the lender is covered and not the borrower. Most people don’t understand the difference.

They hear the word insurance and immediately relate it to their car or home where, when they make a claim, they get paid. PMI is an animal with a different stripe. Yes, the borrower pays for it but the borrower is not the beneficiary. The lender is the beneficiary.

Hence, it is the lender who files the claim and is paid the policy’s proceeds. By the way, if you have a government insured loan, you still have insurance but it won’t be called PMI. Ask your mortgage broker about it at time of application.

So what did we learn? People can get a loan without putting down the magic 20% but they pay a tax for that privilege called PMI. If they default, they don’t get paid the insurance proceeds, the lender does.

This goes against the concept of insurance as most of know insurance. But, it is a protection that has allowed many Americans to buy a home who otherwise would not have the ability. This bump called PMI is with us to stay so understand it and work with it and you’ll be in the house of your dreams quicker than you think.