Private Mortgage Insurance 101: What You Need to Know
Most people don’t have the cash necessary to go out and buy a property outright. Instead, they take out mortgage loans and pay for their homes little by little over many years. If you’re thinking of doing this, your lender might want you to get private mortgage insurance.
What is private mortgage insurance (PMI)?
Private mortgage insurance is an arrangement in which a third party insurance agency compensates a mortgage lender in the event that you default on your mortgage loan. It provides some financial protection to the lender, reducing the risk of loss. You might also hear this type of insurance referred to as a mortgage indemnity guarantee.
In most cases, it is the borrower (you) who pays the premiums on the insurance policy, although some homeowners are willing to cover premiums for a new buyer in order to get the sale to go through. Lenders usually let you pay these premiums along with your monthly mortgage payments, or they let you make a lump sum payment when you close on the property. The lender is named as the beneficiary on the insurance policy, and the lender also might pick the insurance provider for you.
When do I need it?
Generally speaking, a mortgage lender wants to see a loan-to-value (LTV) ratio of at least 80%. Subsequently, you’re usually going to have to get an insurance policy any time your downpayment is less than 20 percent of the appraised value or sale price of the property. When you cannot put more than this down, the lender knows that, if you default, it likely won’t get the full value of the property if it’s sold. The end result is that the lender views your mortgage with an increase in risk and, therefore, wants a little more guarantee it will get its money back. In some instances, lenders might allow you to forgo the insurance in favor of raising your interest rates, depending on current regulations. Some lenders will cancel mortgage insurance once the LTV ratio reaches the 80 percent mark, either automatically or by request, so even if you start out having to have it, you often don’t need to continue to pay for a policy for the entire life of the loan.
What’s the difference between private mortgage insurance and mortgage protection insurance?
Mortgage protection insurance (MPI), also known as mortgage payment protection insurance (MPPI), is essentially a subcategory of life insurance. If you are injured severely or passed away before your mortgage is paid off, then instead of your loved ones having to take on the mortgage payments or move out, the insurance company will pay what remains on the loan. The people you care about will not be financially burdened trying to keep the house. If you do not have a partner or children, and if you are very healthy, getting mortgage insurance is less pressing. By contrast, private mortgage insurance is not related to your health, death or disability, and it pays out if the lender forecloses. Many areas require you to have PMI by law based on the 20% downpayment rule, but having MPI is typically a matter of personal choice.
Private mortgage insurance is a way for lenders to reduce their risks if you cannot put more than 20% of your home’s appraisal or sale value down when you apply for a mortgage loan. If you default on the loan, the insurance company pays off your lender. It is not to be confused with mortgage protection insurance, which is a kind of life insurance that covers your mortgage if you are disabled, severely injured or ill, or die. Not everyone needs this type of insurance, but if you’re considering buying a home at all, you should be familiar with it.