PMI is an insurance policy. The letters stand for Private Mortgage Insurance. This insurance policy pays a lender for financial losses in the event a home is foreclosed.
If you had a small down payment and foreclosed the lender would suffer huge losses. Homes with 20% or more in equity usually have enough money for a lender to cover expenses to sell a foreclosed home. Conventional loans with a 20% down payment do not require PMI.
Why not just call it mortgage insurance? The government also insures mortgages. FHA, VA and USDA loans are all insured by the US government. Conventional loans are loans that are not insured by the government but rather private insurance companies. Private Mortgage Insurance only applies to conventional loans.
Risk factors determine the basis point or BP used by MI companies to determine a monthly payment. The riskier a borrower is the higher the BP. A higher BP means a higher PMI payment.
Example: A 5% down payment may require 35% coverage. A 10% down payment may require 18% coverage.
35% coverage for someone with excellent credit will have a lower monthly payment than someone with fair credit. To determine the payment we multiply the loan amount by the BP and divide by 12.
Example: 35% coverage on 250,000 fixed rate loan. If credit score is 700 or higher the BP is .90 If credit is under 700 the BP is 1.07%. View source
Loan amount 250,000 x (BP) .90 = $2,250 annually or $187.50 per month
PMI can be paid in multiple ways. These are the three most common:
1) No up front premium with scheduled monthly payments.
2) An partial up front premium is paid reducing the amount of the scheduled monthly payments.
3) The entire balance of scheduled PMI payments are paid in one lump sum resulting in no monthly payments.
PMI is a tax deductible expense. However the IRS has rules regarding the PMI deductible so please speak with a qualified tax adviser.
Feel free to contact us with any questions you may have relating to PMI
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