What is PMI?
Private Mortgage Insurance, also known as PMI, is a supplemental insurance policy you may be required to obtain in order to get a mortgage loan. PMI is provided by private (non-government) companies and is usually required when your loan-to-value ratio — the amount of your mortgage loan divided by the value of your home — is greater than 80 percent. It is important to note that PMI is an insurance policy for the lender to ensure that they will be paid back the amount of the mortgage in the event you default on your loan. The premium for this insurance is broken into monthly payments and added to your monthly mortgage payment.
PMI isn’t always a bad thing — it can allow you to make a lower down payment and still qualify for a mortgage loan. In past years, without PMI, many of us would not have been able to purchase our first home. Now with a number of lenders, if you have good credit, you can get a loan with a higher than 80% LTV and still not have to pay PMI insurance.
One thing about PMI insurance that has always bothered me is that you, the borrower, are paying for an insurance for the lender guaranteeing that the lender will be paid in full if you default, yet, the lender still gets to foreclose on the property as well. They get paid by the insurance and get the property too! Seems like a double dip to me.
Your PMI premium is fixed based on plan type (loan-to-value ratio, loan type, loan term, etc.) and is also related to your particular credit history or other individual characteristics. PMI typically amounts to about one-half of one percent of your mortgage amount annually, according to the Mortgage Bankers Association. On a $200,000 mortgage, you may be paying $1,000 per year for PMI. Nonetheless, I have seen PMI insurance premiums that were considerably more than .5% of the loan amount.
Your best bet to avoid this expense is to either put down the required 20%, ask your loan officer if you qualify for a program that does not have PMI even with higher LTVs, or do a combination loan.
A combination loan means that your loan is broken up into two parts. You have a first mortgage up to 80% LTV and at the same time a second mortgage for the balance up to 100% LTV. This type loan can allow you to make a lower down payment and still avoid PMI.
In some cases a subprime loan is a good way to avoid PMI. If the combine interest rates and payments on a combo are going to be uncomfortably high and you have good credit, you could ask your mortgage broker to look at subprime lenders. Subprime lenders do not charge PMI insurance no matter what the LTV is. Also, to borrowers with high credit scores, subprime lenders offer rates that are competitive to conventional lenders.
Subprime lending is often a two to three year proposition as the loans are usually 2 or 3 year ARMS and after the initial 2 to 3 years the rate adjustments could be too high for comfort. However, some subprime lenders offer excellent fixed rates to borrowers with superior credit and the savings of PMI insurance and/or combined costs of a combo loan can make this a more attractive loan option for those borrowers.