PMI was created in the 1950’s and thanks to the creation of this financing option, over 20 million homeowners have been able to buy homes that never could have been able to afford a home under the old rules. Prior to PMI, you had to have 20% down in order to obtain a mortgage.
Although this Mortgage Insurance seems like just “one more thing” you have to pay for the mortgage, the advantage of being able to begin to own a home with as little as 3% down can put a borrower years ahead of where they would be if they had to wait until they had saved up the whole 20% downpayment.
Without PMI, many of today’s homeowners would be in a never ending cycle of renting someone else’s home and make the division of the upper and lower classes much larger. Much of the success of the United States can be attributed to home ownership and Private Mortgage Insurance has played a big part in making this possible.
Why must you pay PMI?
All mortgages are insured in one way or another. When you get a conforming mortgage that is sold off to Fannie Mae or Freddie Mac, there are rules to follow to fit within these conforming guidelines. Fitting within the guidelines allows this mortgage to be Federally Insured.
With Fannie Mae and Freddie Mac mortgages, the Federal Insurance only covers up to 80% of the value and this insurance is to guarantee the mortgage in the case of a default and PMI covers anything over that 80% that you were not able to put down when you purchased or refinanced the home.
Therefore, PMI is required on any Federally Insured mortgage from Fannie Mae or Feddie Mac over 80% of the value of the home.
This additional insurance, provided by private companies, is collected along with your mortgage payment and passed on the the Private Mortgage Insurance Company just like escrowed taxes and insurance are passed on the the Homeowners insurance company and the county to pay the bills.
How to not have PMI
There are two ways to avoid having PMI.
The first way is to not take a first mortgage that is greater than 80%. A second mortgage is taken out to cover the difference between the actual downpayment and the 20% down. These are called piggyback loans, because the second mortgage is on top of the first mortgage. Often you will hear some call this an 80-10-10, where the 1st mortgage is 80%, the 2nd mortgage is 10% and the downpayment is 10% or even an 80-20 mortgage where the second mortgage is the whole 20%.
The second way is to take a mortgage that will not be sold to Fannie Mae or Freddie Mac or to have a mortgage that does not fit the confoming guidelines and can not be sold to Fannie or Freddie. These are called non-conforming loans or sub-prime loans.
Sub Prime Mortgages or Non-Conforming Mortgages often do not have PMI because the sub prime company will have it’s own insurance on the mortgage and part of the higher interest rate on sub prime mortgages comes from covering this insurance.
The Lender is paying the Mortgage Insurance bill and passing it on to the borrower in the form of a higher interest rate and higher mortgage payment instead of a separate bill.
PMI is not a fixed payment, but based on Insurance Rates
It is not as simple as saying, “OK, I will only put 10% down and pay PMI. What does that cost, like $40 a month or something?”
This is an insurance bill. Just like the insurance on a $20,000 car is more than the insurance on a $15,000 car, the same is true with mortgage insurance. The more of that 20% that the borrower could not come up with, the higher the mortgage insurance payment will be and the larger the dollar amount that this insurance needs to cover, the higher the payment will be too.
In addition, there are 5 different rates that apply to mortgage insurance in relation to how large the LTV is.These different rates that are applied to the dollar amount kick in at
80-85%, 85-90%, 90-95%, 97% and 100%
The higher insurance rates are based on the theory that the less money you have down on the house, the higher the risk is that you may just walk away from the home and mortgage. There are also different rates depending on whether this is a 15 year mortgage or a 30 year mortgage.
Although the numbers need to be calculated indidually on each mortgage to determine the insurance payment, the rate for the next level is considerably higher than the previous level.
In other words, saving less for a down payment may not only result in a higher interest rate and a higher payment, but also a higher PMI payment too. Consider all the costs to not waiting to save a bigger down payment.
An Example
To give you an example in dollar amounts: (only an example!!) Here are the PMI premium payments on a $100,000 mortgage, depending on how much you have put down to get to this same $100,000 mortgage. This will give you an idea of how fast it goes up!
| LTV |
Monthly PMI Payment
for 30 year mortgage |
Monthly PMI Payment
10, 15, 20 year mortgage |
| 80.01% – 85% |
$26.67
|
$15.83
|
| 85.01 – 90% |
$43.33
|
$19.17
|
| 90.01% – 95% |
$65.00
|
$21.67
|
| up to 97% |
$75.00
|
$65.83
|
A look at Borrower paid MI versus Lender paid MI
As noted above with some non-conforming or sub-prime mortgage sometimes the Lender pays the mortgage insurance bill for you and you pay a higher interest rate instead of a separate mortgage insurance payment.
When you pay the MI payment this is called “Borrower Paid MI” and when the Bank pays the mortgage insurance payment this is called “Lender Paid MI”
This choice is also available on many of the conforming loans. Always ask if this is an option for you and if it makes any sense for you because Mortgage Insurance is not deductible whereas the higher interest paid from a higher interest rate is deductible.
Usually the two payments are very close whether the borrower or the lender pays the mortgage insurance.
The option of the higher interest rate will make sense if you are not intending to keep the loan for a long period of time because it is now deductible and you will be making that higher payment the whole time you have the mortgage.
If this is a mortgage that you will keep for the whole 30 years, don’t take the Lender Paid PMI. The higher interest rate will never go away whereas the PMI will be cancelled once the balance is less than 80% of the value of the home.
Summary
Hopefully, this article has explained how PMI really works as there does not seem to be a whole lot of information on the subject out there.
Basically, PMI is just an insurance payment that let’s you get into a house without having to save 20% and really is a great innovation that has allowed many, many people to become homeowners.
Just like anything else to do with mortgages, PMI has different ways to be approached and makes sense for some borrowers and does not make sense for others.
