Private mortgage insurance works a bit differently than other forms of insurance like health or life insurance. To understand how it’s different, you first have to understand what it is. Investopedia.com defines private mortgage insurance, which is sometimes abbreviated as PMI, as “A policy provided by private mortgage insurers to protect lenders against loss if a borrower defaults.” Yes, you read that correctly; private mortgage insurance is insurance coverage for your mortgage loan provider on which you pay the premium. That’s the first difference.

The second major difference between private mortgage insurance and many other forms of insurance is that PMI is not optional. A mortgage lender can require that you, as a homebuyer, pay private mortgage insurance if you do not or cannot afford to make at least a 20% down payment towards the purchase of your home. Though many aspects of your mortgage loan may be negotiable, PMI typically is not; it’s usually a condition on unconventional loans.

Generally, PMI is added on to the cost of your loan. The cost for PMI can vary based on the provider from whom you obtain the PMI but a good rule of thumb is the 0.5% rule. That’s to say that the annual cost for most private mortgage insurance will be approximately 0.5% of the mortgage loan price. Let’s look at an example to see how the financials look…

Scenario:
Home price – $220,000
Down payment – $22,000 (which is 10%)
Fixed interest rate – 6.75%
Loan term – 30 years

Based on this scenario, the actual loan amount you’d be financing is $200,000 (home price – down payment). Therefore, your mortgage loan payment would be $1,297.20 per month. Since you would be financing $200,000 and paying less than 20%, it’s highly likely that the lender would require PMI, and that would cost you an additional $1,000 per year; broken down as a monthly payment, that would be $83.33 per month. Therefore, you’d be looking at a monthly mortgage + PMI payment of $1,3850.53.

Another difference between private mortgage insurance and other types of insurance is the option to cancel. With health insurance, life insurance, car insurance, etc., you can cancel anytime you wish. That’s not the case with private mortgage insurance. With PMI, you must pay the premium until you have paid at least paid 20% of the mortgage principal back; some lenders who make loans to “high-risk” buyers may require PMI until up to 50% of the principal has been paid.

While having to pay private mortgage insurance is an additional cost you may incur as a homeowner, don’t let that discourage you from looking into homeownership. After all, if you don’t have a 20% down payment saved up, PMI makes it possible for you to become a homeowner as long as you can qualify for a loan. That’s something that no other form of insurance can do for you! Besides, when you put things in perspective-pay a couple extra bucks each month for PMI and own a home or not pay PMI and keep paying rent-I think PMI is certainly worth the price.

If you are considering buying a new home, then you may already know that there are many requirements that potential home buyers must meet. One such requirement is private mortgage insurance. Private mortgage insurance is a form of insurance that is designed to provide protection for the lender against non-payment, should the borrower default on a mortgage loan. The primary benefactor of mortgage insurance is the lender. There are no protections afforded to the borrower with these kinds of policies. You should understand that when you purchase private mortgage insuranceI coverage, you are paying premiums with every mortgage payment to protect your lender.

There is generally no choice about having this coverage as most lenders will require that you obtain private mortgage insurance. The main reason that this is mandatory involves the condition that does benefit you as the borrower: the low down payment on the mortgage. Naturally, there is a higher level of default risk when a mortgage loan is given with a low down payment, and that must be accounted for and secured against on the part of lender.

Additionally, private mortgage insurance gives mortgage companies the ability to offer loans that in other cases would be considered too risky to be purchased by third party investors, such as Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). Retaining the ability to sell loans to these investing companies is important to lenders because it plays an important role in maintaining the liquidity of the mortgage market, which furnishes mortgage companies with the funds to create new loans for additional home buyers.

Needless to say, private mortgage insurance is not a popular form of insurance to buy, since it has no inherent value for the one purchasing it. Again, the lender will be the beneficiary of private mortgage insurance, not you as the buyer. Yet, it is a necessary part of brokering a mortgage deal, to supply you with the financing to get that house you want. Mortgage loans exist to provide more people with the opportunity to own their own homes. Yet lenders have interests that they need to secure when they take enormous risks by providing financial assistance to multiple borrowers. This is where the private mortgage insurance comes into play in modern mortgage loan agreements.