N.B.- This post is an excellent starting point but gets better as the reader scrolls through the comments. I was fortunate enough to draw the attention of my friend Bill Archambault , long-time lender and Realtor. He clarifies a few fine points and offers an opinion about negotiating short sales.
PMI is known as the acronym for private mortgage insurance. Private Mortgage Insurance is used when a borrower has less than 20% for a downpayment. Private mortgage insurance protects mortgage lenders against potential losses in the event of borrower default. The insurance company, collects a monthly premium from the borrower (based on risk analysis) and agrees to pay the lender a certain amount of money if the loan defaults (usually 20% of the loan amount). It's model was based on FHA loans and their mortgage insurance premium (called MIP, probably to confuse you). FHA and VA offer guarantees to the lender equal to as much as 25% of the mortgage balance.
If a borrower defaults on his conventional mortgage (goes 90 days late on a payment), the lender files the state-specific foreclosure notice and sends in a claim to the insurance company to recover as much as 20% of the mortgage balance. This, in turn, gives the lender a smaller risk when the lender sells the property to recover their losses.
Let's assume we have a $300,000 loan for a property that was purchased last year for $317,000. Could that property have dropped in value since October of 2005 ? Well, if it was a condo in my hometown, San Diego, it may be selling for as little as $260,000 today. Assume it costs about 8% to sell the property. You, the Realtor, should know two things:
How much will the lender receive from the insurance company if the borrower defaults?
$300,000 times .20= $60,000
What price must the lender sell for to not have a loss?
Well, the lender's exposure has been limited to $240,000 now that they received $60,000 from the mortgage insurance company. We take $240,000 divided by 92% (remember that it costs 8% to sell so the 92% represents the net proceeeds). $240,000/.92= $260,900.
Why is this so important to you, the professional Realtor? When negotiating an offer for a property that would result in a short payoff to a lender, you need to remember this fact: PMI claims will mitigate some of that loss. If you know that a seller has PMI on their mortgage, you have that much more wiggle room when negotiating a short sale with the lender. Lenders have been known to attack Realtors' commissions as much as 50% when a short sale exists.
Knowing your numbers and how PMI affects a lender will help you defend your commission. If you understand the net effect the sale will have on a lender, your short sales will go much more smoothly.