Private mortgage insurance (PMI) protects the mortgage lender if a homeowner defaults.
PMI allows the lender recover some of its costs and losses after foreclosing and selling a repossessed home.
PMI rates vary by loan type, loan size, and loan characteristics. The higher the risk to the bank, the higher the cost of PMI.
Following are two types of PMI:
- Borrower-paid mortgage insurance
- Lender-paid mortgage insurance
Borrower-paid mortgage insurance is the more common version of PMI. It may be payable up front, payable monthly, or both. However, once the mortgage balance is reduced to 80% of the home's value, PMI may no longer be required by a lender.
This reduction can occur by principal being paid down, home appreciation, or a combination of the two.
With lender-paid mortgage insurance, there is no monthly payment because the mortgage note's interest rate is increased and is, therefore, "self-insuring". That is, the lender collects higher payments each month and usually buys an insurance policy with the extra proceeds.
Another type of insurance is called homeowners insurance, or hazard insurance.
Homeowner's insurance is property insurance that protects against losses in the event of a catastrophe.
Mortgage lenders require borrowers to carry homeowners insurance because it protects the bank if the home is destroyed. However, it's a good idea to have additional coverage for personal property and for liability related to accidents that occur on-site.
For example, if a home is destroyed in a fire:
- The homeowners insurance will repay the lender for the amount due on the mortgage
- The personal property insurance will repay the homeowner for personal possessions destroyed
- The liability insurance will protect the homeowner from third-party claims related to the fire
Homeowner's insurance is typically paid in annual installments to an insurance company and rates vary by type of home and type of coverage requested.
Wikipedia--Private Mortgage Insurance