Private mortgage insurance (PMI) is a type of mortgage insurance that provides coverage for the lender and not the borrowers. In PMI, mortgage borrowers will have to pay an amount whenever they take mortgage from a lender. This is to protect the mortgage lender peradventure the borrower refuses to complete loan payment.
A Little More on What is Private Mortgage Insurance
Private insurance companies provide PMI for the benefit of mortgage lenders. In most cases, it is when you have a conventional loan that you will be required to pay PMI, this means as a borrower, you will make an initial payment of less than 20% of the value of your home. Hence, the higher the purchase price of your home, the higher the PMI, though it is still the same ‘less than 20%’ rate. This is why borrowers often say PMI is costly.
Paying for Purchase Mortgage Insurance
The mode of payment of PMI is often flexible but differ from one lender to another. While some lenders will offer borrowers many payment options, some will offer limited options. The most common way PMI is paid is through monthly premium which is added to mortgage payment. The premium is also displayed on both loan estimate and closing disclosure.
Another way to pay PMI is through a one-time up-front premium which is usually paid at the closing of the PMI. However,up-front payment relinquishes your entitlement to a refund after moving or refinancing. Some lenders offer borrowers the choice of using both upfront and monthly premiums at the same time. Before choosing any of the payment options, ensure you consult with your loan officer and calculate the benefits and downsides.
Evaluating PMI in Mortgage Loans
As a mortgage borrower, don’t just pick a loan that requires PMI, ensure that you weigh your options before doing so. Although, PMI puts you at the advantage of securing a loan that you might not be able to get ordinarily, PMI is costly. Aside from its cost, it doesn’t protect you but the lender.
There are certain factors you need to consider when choosing a PMI loan. These factors include the availability of conventional loans without PMI, the nature of the lender, whether PMI or loan interest rates affect your taxes, how long you will stay in a home, general mortgage market conditions, among others.
Mortgage borrowers and homeowners sometimes cannot differentiate between mortage insurance and PMI. Before you choose a mortgage package, you need to have a clear understanding of both concepts. Mortgage insurance is paid under an FHA mortgage loan while PMI is usually paid on conventional mortgages. FHA mortage loans are approved by Federal Housing Administration and this category of loan is designed for borrowers with low or moderate incomes. These borrowers are required to pay Mortgage Insurance Premium (MIP). MIP have lower minimum down payments and credit scores than PMI which is a payment of less than 20 percent of the property purchased.
Many homebuyers see PMI as a great way of purchasing a their dream houses due to many disparaging reasons. This paper however highlights six reasons why homebuyers should avoid PMI. The reasons are as follows;
- Cost – PMI is quite expensive, as a mortgage borrower, PMI demands between 0.5% to 1% of the loan as interest. So, the higher the loan, the higher the PMI you will pay.
- Your heirs do not enjoy any dividend from PMI, even after your death.
- As at 2017, PMI was still tax deductible but since then, PMI is no lobger deductible.
- PMI payment goes on and on, there is long payment duration.
- It is difficult to reverse or cancel.
Since many homebuyers have good reasons to avoid PMI, how to avoid it becomes the next question. Reasons ranging from cost, non-deductibility, long payment duration among other reasons are why mortgage borrowers need to avoid PMI. This discussion presents ways through which PMI can be avoided. Piggy-back mortgage is one of the ways to avoid PMI, this entails that if a buyer has saved up to 10% of the price of a home, an 80/10/10 agreement can be made between the buyer and the mortgage company. Although, the terms of piggy-back loans are sometimes risky, splitting up the loans will help the buyer deduct the interest and avoid PMI altogether.
Option-based pricing model plays an important role in determining how mortage contracts change and their effects afterwards. This study examines changes in mortgage contract and insurance values using the option-based pricing techniques.
In an economic setting, diverse factors can cause changes in mortgage contracts, this study evaluates the role of price-based models in estimating mortgage prices that have impact on the economic environment.
References for Private Mortgage Insurance
Academic Research on PrivateMortgage Insurance
• Redlining, the Community Reinvestment Act, and private mortgage insurance, Ross, S. L., & Tootell, G. M. (2004). Journal of Urban Economics, 55(2), 278-297. Redlining refers to an act of refusing borrowers a Loan or insurance because they are perceived to come from area with poor financial risk. The paper examines redlining as a community reinvestment act and private mortgage insurance. This redlining is seen as how mortgage lenders treat borrowers based on their area or income composition. It is however discovered that lenders may treat borrowers with favorable racial or income composition better than those with financial risk incomes. This study finds out that lenders are not likely to approve loans for borrowers in low-income neighborhoods because they are considered as poor financial risks borrowers.
• State foreclosure laws, risk shifting, and the private mortgage insurance industry, Clauretie, T. M. (1989). Journal of Risk and Insurance, 544-554. Mortgage insurance companies suffered great damages in the past years as regards mortgage lending. This resulted in lenders using risk shifting techniques such as securitization to reduce their losses. Due to the fact that lenders incurred substantial losses in the past, especially between 1980 and 1986, there is an undying desire to identify risk factors of mortgage borrowing. This paper examines the state foreclosure laws and risk shifting that private mortgage insurance companies use as well as the implications of the judicial requirements of foreclosure on PMIs. The paper also highlights the losses insurers by lenders as a result of these laws.
• Private mortgage insurance, Canner, G. B., & Passmore, W. (1994). Fed. Res. Bull., 80, 883. This paper discuses the lender’s mortgage insurance otherwise called PMI. The private mortgage insurance is issued on conventional loans and it is meant to protect the mortgage lenders. Mortgage borrowers, especially those who opt for conventional loans under PMI pay less than 20% of the mortgage loan for a duration. PMI insures lenders against the risks of mortgage losses, that is, if the mortgage borrower is unable to pay back the loan and the lender is unable to redeem their cost after sales and foreclosure, PMI offset the losses in benefit of the mortgage lender.
• Pricing private mortgage insurance, Swan, C. (1982). Real Estate Economics, 10(3), 276-296. There are different pricing models of private mortgage insurance but in most cases, the lender gives the pricing options for the borrower. So, pricing in PMI is often within the tenets of the lender. This paper is a study on pricing in private mortgage insurance. It discusses the pricing-based techniques of PMI.
• The Private Mortgage Insurance Industry, the Thrift Industry and the Secondary Mortgage Market: Their Interrelationships, Browne, D. G. (1978). Akron L. Rev., 12, 631.This paper discusses the connection and interrelationships between the PMI industry, the thrift industry and the secondary mortgage market. A Thrift industry is a industry that allows members to save and also give loans. The Secondary Mortgage Market on the other hand is a platform where home loans and service rights are traded between lenders and investors. This paper studies the relationships between PMI and these two principal participants.The laws binding and regulating these principal participants, their operations, possible legal changes, as well as their observations are also discussed.
• Home Equity Loans and Private Mortgage Insurance: Recent Trends & Potential Implications, Bernstein, D. P. (2008). This study examines the effects of home equity loans on private mortgage insurance paying attention to recent practises. PMI on home equity loans helps mortgage lenders to offset loan losses that they incur when a mortgage borrower refuses to pay back their loan. However, the potential implications can either be positive or negative depending on home equity loans and PMI trends.
• Understanding the Cost of Private Mortgage Insurance, Colquitt, L. L., & Slawson Jr, V. C. (1997). Journal of Applied Topics in Business & Economics. Generally, the cost of PMI is between 0.5% to 1% of the entire loan amount that a mortgage borrower collects and this is to be paid on an annual basis. Also, the cost of private mortgage insurance (PMI) is largely determined by the loan amount or on the percentage of a borrower’s home’s value. This paper discusses why it is important that mortgage borrowers understand the cost of private mortgage insurance before collecting conventional loans. However, almost all PMI companies that sell mortgage insurance have a PMI cost which is between 0.5% to 1%.
• Growth and Prospects of Private Mortgage Insurance Activity, Rapkin, C. (1974). Real Estate Economics, 2(1), 89-106. In recent times, there is an increasing number of homebuyers and this is largely due to the availability of conventional loans for mortgage borrowers. This paper evaluates the activities of Private mortgage Insurance industries and their prospects in further stimulating ad increase in the number of homeowners. This paper also includes a study of the growth or advancement of PMI in terms of insurance activities.
• Risk and trust: homeowners and private mortgage insurance, Ford, J. (2000). Policy & Politics, 28(4), 527-540. Both homeowners and mortgage lenders have certain expectations of the mortgage market and whether their expectations are met or not depend on economic factors among other factors. Also, the relationship that exist between homeowners and mortgage insurers is that of risk and trust. This paper examines the risks and trusts entailed in mortgage industry drawing insights from the relationship that exist between homeowners and mortgage industries.
• Addressing Financial System Pro-Cyclicality: A Role for Private Mortgage Insurance, Joyce, J. R., & Molesky, M. F. (2009). Housing Finance International, 23(3), 30-37. This paper discusses financial system pro-cyclicality as an issue in the mortgage industry and how addressing this issue lies with the private mortgage insurance. To proper understanding, procyclicality of financial system has to do with the mutual interactions between the real economy and the financial system and they reinforce each other. The financial system pro-cyclicality however has the tendency of increasing financial risks as this needs to be addressed by Private Mortgage Industry.