What Does Private Mortgage Insurance Cover and What’s in it for You?

Simply put, private mortgage insurance covers lenders against losses they may suffer due to non-payment and consequent foreclosure.  It is called private because the US government also insures and guarantees loans for qualified borrowers, and mortgage insurance not obtained through the government is therefore called private.  Private mortgage insurance is commonly referred to as PMI.

If you think that mortgages protect lenders from loss by backing up the loans with the value of the property, then you are correct, but only partly so.  Suppose you buy a house and can no longer make the payments.  To recover its money, the lending institution now has to foreclose the house, that is, take over the deed and sell it.  By doing so, the lender must incur many expenses, such as legal fees, real-estate broker commissions, property taxes owed while the house is in the lender’s possession, home owner’s insurance, etc.  If the amount owed is only a little less then the value of the property, the lender may still lose a pile of cash. 

Now suppose that in addition to all that, property values also went down, and now the value of the property is less than the amount owed.  This can really hurt!  That’s why mortgage lenders make it a practice not to give loans greater than 80% of the property value and that means a 20% down payment.  Many years of experience have shown that a margin of 20% provides good protection.

But what about all those houses bought for 10%, 5% or even no money down you ask?  There are ways of getting around the 20% rule, while still providing the lender with the desired protection, and one of them, of course, is private mortgage insurance.

Private mortgage insurance coverage is provided to the lender by a third party insurer.  In case of foreclosure, the insurer pays the lender for any losses not covered by the sale of the property.  Even though PMI is given to the lender, the borrower pays it.  What in it for you?  You get a loan with less than a 20% down payment.

Private mortgage insurance coverage doesn’t last the lifetime of the loan, only until the amount owed falls to 80% or less of the property value.  This can happen either because enough payments have been made or because the market value of the property has risen.  In either case, once the 80% mark is reached, it may be your responsibility to notify the lender that you wish the mortgage insurance to be removed.