What Is PMI/MI & Why Do I Have To Pay It?

Anna 'Banana' Kruchten is hosting an ActiveRain contest this month titled "FAQ Break Into Summer Organized Contest" in which she is challenging us to write 5 new posts with answering 5 consumer FAQ's.  As I have stated on my previous blogs in this challenge, this is an easy one for me.  There are at least twice that number of questions I am asked on a regular bases by consumers.  I have already posted two blogs on the most FAQ I get from consumers "What Do I Need To Do To Get Pre-Qualified For A Mortgage?" and "Why Do I Have To Pay Points?"  So lets go on to the third question I am asked often.

What Is PMI/MI & Why Do I Have To Pay It?

When I first became a Loan Originator, I thought that everyone knew what PMI was and what it stood for, after all I did, and I knew nothing about the mortgage business.  Well it quickly became very evident that was not the case, and that many people have not even heard the term before.

PMI stands for Private Mortgage Insurance, and it is an insurance Borrower pays on behalf of the Lender, on every Conventional Loan (Fannie Mae & Freddie Mac) if they do not make at least a 20% down payment at the time they acquire a mortgage from a Lender.  Yes you heard that correctly, the Lender needs to protect themselves for at least 20% of every loan they make, and it is the Borrower who pays for it.  This seems unfair at first, but once it is explained why the Lender needs to be protected for at least 20% of every loan it makes a little more sense.

The reason why the Lender needs to be protected for at least 20% of a mortgage, is in case the Borrower defaults on the mortgage and the Lender has to foreclose on them.  20% is the amount most Lenders feel is required to make them whole for the costs the Lender incurs during the foreclosure process. 

When a Lender forecloses on a Borrower they have to hire an Attorney to represent them during the foreclosure, continue to pay property taxes, and carry homeowners insurance.  These cost can be substantial until the property is foreclosed and sold. 

Once the foreclosure is completed the Lender hires a Realtor to sell the property and has to pay the Realtor a commission.  But before the property is even put on the market for sale, the Lender in most cases needs to restore the property to the point it is a salable property.  This is needed because when a Lender forecloses on a Borrower, many times that Borrowers does very destructive things to the property before the foreclosure is completed.  They put holes in the walls, rip out light fixture, toilets, sinks, destroy carpets, as well as many other destructive things.  Restoring the property to the point of being able to sell it can be very costly.

The PMI payment will vary with the percentage the Borrower puts down as a down payment when they acquire the mortgage.  The PMI payment are factored at 3%, 5%, 10%, and 15% down payments .

Mortgage Insurance Premium (MIP) also know as just simply as MI, is the Finance Housing Administration (FHA) version of PMI, but unlike PMI there is very little difference in the MI payment regardless how much a Borrower puts down.  And unlike a Conventional Mortgage, MI is charged on every FHA Mortgage, even if the Borrower makes a 20% down payment.  If the down payment is 10% or more, the MI will be on the loan for 11 years.  If the down payment is for 10% or less, the MI will be on the loan for the life time of the loan.  So why would a Borrower who has 20% to put down on a mortgage take out a FHA Mortgage?  The answer is simple, they would not unless it was because their credit scores are to low, or their Debt-To-Income Ratios to high to qualify for a Conventional Mortgage.  FHA mortgages are far more lenient on credit scores, and Debt-To-Income Ratios than conventional mortgages.

In my next blog I will answer the question that is the natural next question on this topic, "When Can I Eliminate The PMI Or MI?"