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Question: What is PMI?
Private Mortgage Insurance (known as PMI) is mortgage insurance used on a conventional loan and mortgage insurance bought from the government is designed for Federal Housing Administration (FHA) loans.
So, what is mortgage insurance?
Mortgage insurance is used to protect the lender in the event of foreclosure. This insures that the lender gets paid if the borrower defaults on their loan.
If your down payment is less than 20 percent of the value of the home and you’re getting a conventional loan, the lender will require you to carry mortgage insurance. Mortgage insurance rates typically vary, but the insurance rate is typically cheaper as the down payment increases.
Once you reach 80 percent LTV (Loan To Value), as the borrower you should contact then lender to see if the mortgage insurance can be remove altogether.
If a FHA loan is being obtained, there is an up-front mortgage insurance premium (known as a MIP) and an annual premium, which can be paid monthly.
With government loans however, mortgage insurance is typically required throughout the life of the loan. However, if a borrower put down 5 percent or more, the borrower’s monthly mortgage premium rate is reduced a bit.
A VA loan, government loans for service members, veterans, and eligible surviving spouses, has an up-front fee (know as a funding fee) and no annual premiums.
With conventional loans, some lenders can provide the borrower with a second trust, which could help the borrower avoid paying mortgage insurance.
This loan would allow the borrower to obtain an 80 percent first trust loan (avoiding mortgage insurance since the loan to value is 80 percent or less) and second trust loan to cover all or a portion of the remaining 20 percent LTV.
Please note the interest rate on a second trust can be rather high depending on current interest rates and the borrower’s current financial situation.
If the borrower qualifies and if the lender can provide a second trust, the borrower could save money, as the interest on the loan(s) is tax deductible. So instead of paying a first trust, deducting the interest from that loan, and paying monthly mortgage insurance (not tax deductible) the borrower can eliminate the mortgage insurance and deduct the interest on both the first trust (80 percent LTV loan) as well as the second trust (the 20 percent or less LTV loan).
Please contact your accountant to be sure that this will work for your own financial situation.
There are two types of PMI — borrower paid and lender paid. The information above refers to borrower paid PMI, which is where the borrower pays monthly mortgage insurance until the LTV is low enough so it can be removed.
Lender paid mortgage insurance is where the lender increases the interest rate to pay the PMI and eliminates the borrower from paying the monthly mortgage insurance. Based on the scenario presented before, lender paid mortgage insurance would seem like a no-brainer since the interest is tax deductible.
However, with lender paid mortgage insurance, the borrower is locked into that higher interest rate for the life of the loan, no matter how much of the loan is paid down. The borrower would have to refinance the loan in order to decrease the interest rate once they have reached 80 percent LTV.
Please note that most lenders will not remove PMI on a conventional until the loan is paid down to at least 78 percent LTV.
Jason Nader with Bay Capital Mortgage assisted with this response. I recommend contacting Jason for any and all of your lending needs.