PMI IAN

Posted January 17, 2008

PMI In a Nutshell (IAN)

Ok. So the headline was designed to get your attention. After all, PMI (private mortgage insurance) isn’t the sexiest of topics. But it is a critical part of the mortgage process today. For most people, private mortgage insurance is the only way they will be able to buy a home or refinance their existing mortgage! So with something so critical to this process, maybe we should discuss it a bit, don’t you think?

What is PMI?

PMI is short for Private Mortgage Insurance. This is an insurance policy that protects the lender in case of default of the borrower. The idea is that if a home owner loses their home to foreclosure due to lack of repayment, the bank will only get a portion of the money they lent back when the home is sold. Private mortgage insurance is designed to cover the remaining deficit (if any) for the lender.

When a home is foreclosed on, most lenders expect to get at least 80% of a home’s value. So when a borrower takes out a loan that is more than 80% of the home’s value, most lenders want insurance to cover that additional exposure. In order to offer the loan, the lender will require the borrower pay for the private mortgage insurance to cover the additional risk.

Types of PMI

The are 3 basic types of Private Mortgage Insurance.

Borrower Paid Monthly PMI.
As the name indicates, the borrower pays a monthly premium for the insurance coverage. This remains in effect normally until the loan balance reaches 78% of the home’s value at the time the loan was provided. So if your home’s value when you obtained the loan was $200,000 the mortgage insurance should normally end when the loan balance drops below $156,000. There are other ways to remove this form of PMI early. Speak with a mortgage professional to discuss those options.
Lender Paid Monthly PMI.
Sure, there are cuter names… “Tax Advantage” would be my favorite. But the bottom line here is that your mortgage rate is slightly higher that the Borrower Paid Monthly mortgage rate would be so that the lender can make the difference up to pay the private mortgage insurance premium for you. In other words, you pay for the mortgage insurance through a higher rate. The reason someone would choose this method is for tax advantages.Until recently, PMI was not a tax deductible expense. However, Congress did allow it to be deductible at least for a while and in only in certain cases (see a tax advisor to see if this applies to you.) So if it is not tax deductible, the difference in the rate allows you to deduct the “extra” interest charges. As long as the payment is comparable, this could be a great option. However, this form does not allow the PMI to drop off at 78% of the home’s value. So again, talking to a tax advisor might be in order.
One Time Financed PMI.
This option as it indicates allows you to pay for the private mortgage insurance premium in one lump sum, covering you for the entire life of the loan, while allowing this premium to be financed into your loan. Again, this can have some great tax advantages, especially for short term financing goals with less money down. Like the Lender Paid Monthly PMI, this type of PMI does not drop off at any time during the loan, so talking to a tax advisor is recommended.

How to Avoid PMI

Many people want to avoid Private Mortgage Insurance. Mostly because of tax purposes, as in the past it has not been something you could deduct on your income taxes like interest paid on a mortgage. However, recent laws have changed the deductibility so that may not be as much an issue.

There are ways to avoid PMI. The simplest, yet the most difficult for most, is to put 20% down when buying a home. PMI is only required when the loan amount is greater than 80% of the home’s value (or purchase price.) Another option is called a combo loan, where you would have one loan at only 80% of the home’s value, and another (second mortgage) to make up the rest. In the past, lenders would allow 100% financing with this option (commonly referred to as an 80/20 loan), but this type of combo loan is getting harder to find. Today most lenders will only allow a total of 95% of the home value to be covered by these combo loans, requiring 5% down when you buy. And the rates on the second mortgage are normally higher than the second, so the overall payment must be looked at.

The Bottom Line on PMI

PMI is a great option to help most home buyers obtain the financing they need to buy a home. In most cases, even comparing the combo loans, private mortgage insurance is coming out on top! With its potential for being deductible, and its ability to disappear one day, it is an option most home buyers gladly accept. Either way, be sure to discuss all your options with a mortgage professional to ensure you are getting the right fit for your individual needs. Heck, you may want to call the Ed Nailor Mortgage Team. After all, you are already here!