What is PMI?

By April Young Blackwell, NMLS ID 415648, Certified Mortgage Planning Specialist, Industry Insider

This week I had the honor of working with a client whom I helped buy her first home 11 years ago. It's always wonderful to help someone for the second, third, and forth time. As I was reviewing her options with her, I threw out the word PMI, expecting she would know what I was talking about. She didn't. She politely asked, "What is PMI?"

It's common job hazard for lots of professionals. We speak in jargon that means something to us, but is absolutely mysterious to our client.

I realized that when she was a first time homebuyer, I had helped her with a large down payment assistance program that was available through the City. It enabled her to basically "put down" 20% of the home's value. Therefore, "PMI" was never brought up.

Fast forward to today, she is no longer a first time homebuyer, and even though she recently sold her home and made a very nice profit, she was not going to be able to put down 20% for her new home. It was necessary for her to use most of her profit from the sale of the home to pay off debt.

To answer her question, "What is PMI?" I explained that PMI stands for Private Mortgage Insurance. For most loan programs, if a borrower does not have 20% of the purchase price to put down, they pay an added cost to the lender's mortgage insurance company to protect the lender in the event that the borrower forecloses.

Yes, the borrower pays insurance to protect the lender.

In most cases when a consumer pays insurance it protects the consumer or the consumer's family. Car insurance protects the driver. Life insurance protects the family. Disability insurance protects the one recently disabled. Health insurance is there for the people who pay for it.

But, when you buy a home and do not have 20% to put down, you pay insurance to protect the lender.

That doesn't seem fair, does it?

Well, without Mortgage Insurance, 57% of the market would disappear. Mortgage insurance is an added cost, yes. However, it provides the majority of homeowners the opportunity to build their wealth through appreciating property values, and provides homeowners the satisfaction and security that comes from home ownership.

There are ways to NOT pay PMI monthly. However, a mortgage with less than 20% down, more than likely has some kind of PMI on it.

What are the types of PMI?

1. Monthly

2. Single Premium Borrower Paid

3. Lender Paid Mortgage Insurance

4. Split Premium

5. Reduced Monthly PMI

Please note, not all lenders offer all Mortgage Insurance plans. Consult your local lender about what is available and best for you.

Description of the 5 primary PMI plans.

Monthly PMI is just that. PMI paid monthly.

Single premium borrower paid mortgage insurance is a percentage of the loan amount paid up front. In exchange, there is no PMI paid monthly. This could increase the borrower's cash required to close unless a higher interest rate is chosen that has a lender premium on it to offset the additional cost. Some lenders offer the option to finance this premium vs paying it all up front at closing. Limitations exist, consult your lender.

Lender Paid Mortgage Insurance is where the Lender pays it on the borrower's behalf. In exchange, the borrower either pays higher discount points on the loan or chooses a higher interest rate. This may or may not increase the cash needed to close, depending on the rate chosen.

Split Premium is a hybrid up a lower single premium coupled with a lower monthly payment. The up front premium may be finance eligible.

Reduced Monthly PMI is available in plan with income restrictions or through State Housing Finance agencies.

There are pros and cons for each of these.

PMI may or may not be tax deductible for the homeowner. It depends on what the tax law brings every year. When it is tax deductible, there is an income limit. Article on current state.

Just as interest rates vary depending on your credit score and down payment, so does the cost of PMI. To get the best of everything, the lowest offered rate and the lowest offered rate of PMI, you want to be at a middle mortgage credit score of 760 or higher and have a debt to income ratio that does not exceed 45%. The rate of PMI is highest with the least amount of money down, and lowest with larger down payments.

PMI is not to be confused with other types of home related insurance.

Hazard Insurance, aka homeowners insurance is something the buyer shops for with an Insurance company that offers personal insurance like Home, Auto, Life. Hazard insurance, also referred to by some as a Fire Hazard policy is there to cover losses due to fire, system failures like a water damage from a failed plumbing or appliances. It covers other things as well. Just mentioning a brief description here to contrast it with PMI. PMI is NOT homeowners insurance.

It is also not Life insurance or disability insurance that makes mortgage payments for you if you die or cannot work. It is NOT that.

It is simply protection for the lender so you have the chance to buy a home without saving 20% of the sales price.

Now that I have covered what it is and what it is not, the next time you hear the term PMI, you will be in the know.

To know what the best loan structure is for you, you will want to have a consultation with a Certified Mortgage Planning Specialist or seasoned Mortgage Loan Officer in your market.

If you are buying a home in North Carolina, I would love to help.

I can be reached at [email protected]