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Private Mortgage Insurance

Private mortgage insurance is coverage required by traditional lenders when the borrower has a down payment smaller than 20 percent of the value of the home. Although the term sounds very similar to private mortgage notes, private mortgage insurance is not a type of coverage exclusively for private mortgage notes. Here we clear up the misconceptions about private mortgage insurance and explore its relationship with other mortgage insurance products, including title insurance, hazard insurance and homeowner’s insurance.

What Is Private Mortgage Insurance?

Traditional banks and private lenders require homebuyers to pay for private mortgage insurance when they make a down payment less than 20 percent. Private mortgage insurance, often referred to simply as PMI, protects the lender in case the borrower fails to pay the loan.

Private mortgage insurance fees are based on the size of the down payment and the credit score of the borrower. Typically the fees are 0.3 percent to 1.5 percent of the original loan each year. This annual premium is divided across the 12 mortgage payments throughout the year.

Example Calculation

Borrower Credit Score 720
Home Price $160,000
Down Payment $10,000
Monthly PMI $71

When Can I Stop Paying PMI?

By law, the lender of a non-FHA loan has to cancel PMI when a loan’s balance drops to 78 percent of the home’s original value. However, this process can take several years because most of your initial mortgage payments go toward interest rather than principal.

A savvy borrower can speed this process by keeping track of payments. Though lenders have to automatically drop PMI once you reach 78 percent, borrowers can request PMI to be dropped once the loan-to-value ratio reaches 80 percent.

This request must be done in writing and typically is only accepted by the lender if the borrower has a solid payment history and is up to date on payments. Some lenders will require a new appraisal to determine that the loan balance truly is 78 percent of the home’s current value.

The borrower’s loan amortization schedule should indicate when the loan-to-value ratio reaches this point. Those wanting to save on their monthly mortgage payment would be wise to set an electronic calendar reminder for when this date comes. Based on the previous calculation, the borrower could save $710 by requesting PMI to be dropped at the 80 percent mark.

Mortgage Insurance on FHA Loans

FHA mortgages are the exception to this cancellation policy. FHA loans require the borrower to pay mortgage insurance for the life of the loan. Those with FHA mortgages wishing to avoid paying further PMI must refinance the loan.

Is Private Mortgage Insurance Tax-Deductible?

The short answer is maybe. Whether PMI is tax-deductible is controlled by Congress and historically has gone back and forth. As of 2016, PMI premiums on homes for personal use paid on or after Jan. 1, 2007, were eligible for deductions. As with all financial matters, consult a tax professional to see what deductions you qualify for.

Is PMI the Same as Title Insurance?

Private mortgage insurance is not the same as title insurance, but they are somewhat related. A title is the written evidence of who lawfully owns the property. Title insurance is typically a one-time payment paid at the close of escrow.

Like PMI, title insurance protects the lender. However, unlike PMI, title insurance also protects the borrower. Title insurance protects both parties against property loss because of liens, encumbrances or defects within the title.

Title insurance is not protection going forward from the start of the policy; rather, it is protection against past events and issues with documentation of the property with the previous owners.

How is PMI Related to Hazard Insurance?

Like PMI, hazard insurance is a type of insurance required by lenders. Though PMI is essentially protection for the lender in the event the borrower doesn’t pay, hazard insurance is protection for the lender of the actual collateral on the loan: the property.

Hazard insurance covers a homeowner for damage from fire, smoke, vandalism and other causes. Like PMI, it is often included in monthly mortgage payments.

It is important to note what hazard insurance is not. Hazard insurance is not homeowner’s insurance, which protects against liability concerns. Hazard insurance coverage is typically highly restricted to the types of damages listed in the policy.

What’s the Difference Between PMI and Homeowner’s Insurance?

The biggest difference between PMI and homeowner’s insurance is that homeowner’s insurance is protection primarily for the borrower, not the lender.

The biggest function of homeowner’s insurance is as a financial protection for the borrower from serious damage to the property. Homeowner’s insurance also includes liability insurance, which is coverage in the event someone is injured on your property and legal costs if the injured party decides to sue.

Homeowner’s insurance does not protect against earthquakes, floods or neglect on the part of the homeowner. Earthquake and flood insurance must be purchased separately.

Relationship Between Private Mortgage Insurance and Mortgage Types

Don’t let the names fool you: Even though private mortgage insurance and private mortgage notes use many of the same terms, they aren’t as closely related as you might think. Both private and traditional mortgages can benefit from private mortgage insurance, but private mortgage lenders would stand to benefit the most.

Though most people opt for a traditional mortgage, some homebuyers go with seller financing through a private mortgage. In this situation the seller acts as the lender for the homebuyer. As the lender, the private individual may require a borrower to carry private mortgage insurance.

As a private individual it’s even less likely that the lender in a private mortgage situation has the money on hand to pay for a foreclosure process in the event the borrower doesn’t pay. However, unfortunately for private lenders issuing private mortgage notes, most forms of private mortgage insurance are only for large institutional lenders.