If you’ve ever shopped for a home or considered applying for a mortgage, you’ve likely asked What is PMI? Private Mortgage Insurance (PMI) is a common requirement for those who typically pay less than the recommended 20% down on their home. It is insurance that works to offset risk to the lender and get approvals for those without much cash.
The History of PMI
The mortgage markets have played around with private mortgage insurance since before the Great Depression, but the PMI we know of today really started around the 50’s. The first PMI company was started as an effort to get more approvals for loans, specifically government-backed loans (which were the most common at the time.) The insurance company offered protection against the first 20% of a loss on any defaulted mortgage to help bridge the gap for those who didn’t have that much liquid cash to put down.
Home sales took off after this, bringing more buyers in the 70’s and 80’s. In fact, this one company managed to get 12% of all home loans at the time fueled by PMI insurance.
What is PMI Today?
Things have changed a lot since the 50’s, and PMI is now a requirement for many types of loans. Almost all conventional loans (those not backed by the government) will require PMI for anyone paying less that 20% down. This is most commonly paid by the borrower. The monthly premium payment is added to the mortgage payment that gets paid to the lender each month and get sorted out from there.
In a few rare instances, the lender may choose to pay PMI premiums. This is usually done for loans that don’t actually require it, and it’s built into the financing.
The Perks of PMI
Many people are grateful that PMI exists. Without it, there would be little to no way to purchase a home without 20% cash down. Certain programs, such as the Fannie Mae HomePath program, offers homebuyers access to foreclosed homes with as little as 3% down. PMI pays a big role in how these homes can continue to be sold, and the lender often offers a credit to offset the cost of the PMI insurance to buyers. (They refer to this as “closing cost assistance.”)
PMI also protects lenders from defaults that would cause the home to be worth less than the remainder of the loan amount. With these added protections in place, lenders are more open to risk, and they will consider an otherwise properly qualified homebuyer even if they lack the down payment. When dealing with a buyer making $100,000 a year, for example, they may qualify for a $250,000 home loan. Having $50,000 on hand for a down payment is tough. PMI keeps the home market moving and gives the everyday buyer a chance in even the most inflated home markets.
PMI Dangers
Some people may be qualified on paper to take on a large mortgage. This doesn’t mean it’s a good idea. PMI may be the tipping point to get approvals for more homeowners that aren’t equipped to handle mortgage payments. Factor in the added cost of PMI (usually 1-2% more), and it can really add up. Home buyers need to be made aware how PMI payments will inflate the housing budget each month. It’s also good to be educated on proper steps to cancel the policy. (This can be done when they’ve paid more than 20% of the principal value of the home.)
While the steps to request a cancellation at 20% equity may be cumbersome, recent legislation requires lenders to automatically cancel at a certain point. Specifically, when paid principle plus the down payment reaches 22% of the purchase price, the lender must cancel. The recent Federal Homeowner’s Protection Act guarantees this to happen, even if your home value has declined.
What is PMI Doing for Tax Benefits?
Prior to 2010, PMI payments by the borrower were tax deductible, further sweetening the deal. There are no immediate signs that this tax benefit will return in the near future, however. You’ll have to get your tax relief from some other home-related expense, such as mortgage points and property taxes.
The next time someone asks What is PMI? you’ll have the answer. This concept in home ownership has changed the landscape of real estate for the better (in most cases) for millions of Americans.