What Is Mortgage Insurance and Why Do I Need It?
Conventional mortgage lenders use Private Mortgage Insurance (PMI) as a protection from their exposure to risk of default or foreclosure. Its purpose is to permit buyers with a low down payment to secure a mortgage at an affordable rate.
Private Mortgage Insurance policies are required if a borrower purchases a property with less than a 20% down payment.
Unlike other insurance policies, it is the borrower who pays mortgage insurance, but the bank is the beneficiary of the policy. It is noted that there are some PMI policies that are lender-paid (LPMI) however, the lender recaptures their out of pocket costs insurance costs by raising the interest rate marginally.
Ok, so how does Mortgage Insurance offer a lender protection?
Some homebuyers have ample funds to meet the down payment requirements and thus, avoid paying mortgage insurance entirely. But, for those who cannot, there is mortgage insurance. Adding PMI as a condition of your mortgage helps your mortgage application become more appealing, or creditworthy to the lender’s underwriter.
PMI has several levels of protection. The amount of coverage required for homebuyers putting down 5% would clearly require coverage, which requires a higher monthly premium for the borrower. The amount of coverage required by a lender for a borrower putting down 16% would drop considerably and, the premium would follow suit.
The conclusion: Lenders have recognized over many decades that borrowers who put down 5% (or less) are significantly more likely to default than borrowers who put down 16% or more, and is why the PMI is necessary to offset the potential financial risk.
Is PMI Tax Deductible?
PMI was once a tax-deductible cost between the years of 2008 and 2013. During this time, Congress allowed buyers to write off their PMI mortgage premium payments. However the permitted deduction is no longer available. This becomes another important reason to avoid PMI if at all possible.
Paying PMI is not a life sentence. For most conventional mortgages, lenders are required to automatically drop PMI requirements (and premiums) when the mortgages Loan-to-value (LTV = loan amount/original purchase price) drops to 78% of the original purchase price. Borrowers who seek to be more proactive, can request their PMI insurance be cancelled when the principal balance reaches 80% of the original value of your home.
PMI has a very real purpose and can be quite useful if it is understood and used appropriately; it is not meant as a punishment, but as a means to be able to get the home you’ve always wanted. The more you know, the better prepared you’ll be!
Please contact us for any questions on how we can help you.