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The Purpose Of Your Mortgage Insurance

By Elizabeth Elstien

What is mortgage insurance, better known as private mortgage insurance (PMI)? PMI is insurance required of any residential homebuyer who has a non-government-backed home loan with a down payment of less than 20% of the sales or assessment price. Second mortgages are also subjected to PMI. Find out how PMI works and just who it benefits.

What Is The Purpose of PMI?

PMI allows a homebuyer using a conventional loan to purchase a home with less than 20% down payment. The lender is the PMI beneficiary and the homeowner pays the insurance premiums. This insurance reimburses the lender if the homeowner defaults on the loan. It does not pay the mortgage off for the homeowner. Studies have shown that homebuyers who put less than 20% down on a home are more likely to default on the loan. The lender is taking a big risk in lending with little down payment, so PMI is needed to protect the lender. PMI helps both the lender and the homebuyer, as without it lenders would fund less loans and homebuyers with little cash would not realize the dream of homeownership.

How Are PMI Premiums Paid?

Premium fees differ depending on the underwriter, the loan total and the down payment amount, but may be as much as 1.15% of the loan amount. The homeowner need only pay premiums until the loan-to-value ratio is 80%. The Homeowner Protection Act of 1988 (HPA) requires the lender to tell the borrower at closing how long it will take to reach 80%. Although the lender is not required to cancel PMI until 78% of the loan is paid per HPA, the homeowner is allowed to keep track of principal payments and alert the lender in writing to stop the PMI premiums at 80% to save money. HPA only affects homeowners with loans dating from July 29, 1999 or after.

Are All Types Of Loans Covered by PMI?

Government-back mortgages have their own separate requirements and are not subject to PMI. According to the Internal Revenue Service (IRS), Department of Veterans Affairs' (VA) mortgage insurance is known as a funding fee while called a guarantee fee if purchased through the Rural Housing Service (RHS). Both of these fees are included in the loan amount or paid in full at closing. Federal Housing Association (FHA) has its own mortgage insurance paid by the homeowner for the life of the loan.

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