If you have bought a home in the past, or are considering buying a home, condo or townhouse, then you have probably heard the term Private Mortgage Insurance or PMI.
PMI is an insurance product sold by some private insurance companies. PMI protects a lender in case a homebuyer does not or cannot maintain payments on their home loan or mortgage. In other words, PMI protects lenders from loss if a buyer defaults on their loan.
If you are getting a loan to purchase a home or other real estate, most lenders prefer that you put 20% of the purchase price as a down payment. However, not all homebuyers have that amount of money available for a down payment. It is not uncommon for buyers to only put 15% down, or 10% down, or 5% down, or 3.5% down, or in some cases, no down payment is applied, and the lender provides 100% financing.
To protect the lender’s interests in situations where the down payment is less the 20%, the lender will usually require a borrower to pay for PMI so that the lender is covered in case the borrower later defaults on the loan. The up-front premium charged by insurance companies for PMI is usually a percentage of the loan amount. The up-front premium is normally rolled into the borrower’s mortgage payment. In addition to the up-front premium, most lenders also charge a monthly PMI fee. While PMI increases a borrower’s monthly payment, it does help them get a home loan that they may not otherwise be able to obtain.
Here is an example. If a person is buying a home using a loan guaranteed by the Federal Housing Administration (FHA), the FHA charges 1.75% of the loan amount as an up-front PMI fee, and 1.25% of the loan amount as a monthly PMI fee (as of April 9, 2012 based on 3.5% down payment). So if a person is buying a home for $300,000 with a 3.5% down payment ($10,500), the up-front PMI will be around $5,250 (which can be added to the loan), and the monthly PMI will be around $301 (calculated by $289,500 x 1.25% / 12 months).
As an alternative to PMI, a few lenders offer two loans to reach the amount of money needed by a borrower. For example, a borrower may obtain a first mortgage for 80% of the loan amount, and a second mortgage for 20% of the loan amount, which totals 100% financing. Borrowers must strict meet credit, income and debt requirements to be eligible for these types of loans, and the number of lenders who offer 100% financing is very limited. However, the Veterans Administration (VA) still offers 100% financing to active-duty military personnel, eligible beneficiaries and retires.
Homebuyers should remember that PMI protects only the lender and not the homebuyer. If a borrower does not maintain payments on a mortgage, the lender will mostly likely initiate foreclosure proceedings.
Be sure to shop various lenders to identify the best loan program for your particular situation, and call your Realtor or loan officer if you have any questions.
