Assuring that that the loan market remains liquid and loans remain available are two large Federal agencies known as Freddie Mac (FHLMC) and Fannie Mae (FNMA), also known as the secondary market. Lenders make loans and, often, sell these in the secondary market. In exchange for this liquidity, the agencies have strict underwriting guidelines that must be complied with by lenders; one of those guidelines is the requirement for borrowers to obtain private mortgage insurance (PMI) when making a down payment of less than 20%. An exception is made for veterans using their VA loan benefits. VA loans do not require any PMI.
PMI protects the lender against borrower default. The cost of PMI depends on several factors, such as the borrower's credit, amount of down payment and the length of the loan, but generally ranges from 0.41% to 0.87% per $100,000 borrowed.
PMI is required until the borrower has at least 22% equity in the home, through a combination of principal reductions and property appreciation. Although the lender should drop the requirement at that time, it may not be aware of the rise in equity. Therefore, borrowers should keep track of their equity and advise the lender when the 22% threshold has been reached, or refinance the mortgage at that time.
FHA loans also are subject to a mortgage insurance payment. Borrowers using a FHA loan must pay a mortgage insurance (MI) premium similar to PMI. However, on 30 year FHA loans, where the borrower made a down payment of 5% or less, the MI requirement is never dropped, regardless of the amount of equity. At 0.85% per $100,000 borrowed, MI is also more expensive than PMI; the only way for a FHA borrower to quit paying this MI is to refinance the loan.
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