Private Mortgage Insurance (PMI) has long been touted as a benefit that allows borrowers to purchase property with less than a 20% down. But who is the real beneficiary of PMI? We are all told that PMI is insurance that pays the lender if we default on our mortgage. While true, this does not tell the whole story. There is a lot that we are not told.
If PMI is a condition of a mortgage, here is what the lender must disclose:
- As part of a "good faith" estimate of closing costs, the lender must provide an estimate of the PMI premium.
- At closing and annually thereafter, the lender must notify the borrower of available cancellation options. In most cases, PMI may be cancelled when the mortgage is paid down to 80% of the lower of the selling price or the original appraised value. It will usually be cancelled automatically when the amortization of the loan takes the mortgage balance down to 78%.
Among the things most people do not know:
- The borrower is not a party to the mortgage insurance policy. The lender does not have to disclose either the name of the insurer or the amount of the insurance purchased. Yet the buyer typically is responsible for the premiums.
- Lenders can purchase protection for up to 30% of the mortgage amount without disclosing to the buyer any more than the premium. For example, you buy a $200,000 home with a 10% down payment of $20,000, financing the balance with an $180,000 mortgage. The lender can protect up to 30%, or a total of $54,000, with mortgage insurance with the buyer paying the premium.
- The PMI insurer can pay anyone along the transaction line for services rendered that either reduce the risk of the loan or reduce the insurance company's expenses. This implies that they can pay commissions to the lender. Understand that it comes out of your pocket.
- The monthly premium for most PMI is fixed. In other words, as the balance of the mortgage declines, presumably along with the risk to the lender, the borrower continues to pay the same premium based on the risk assessment at the time the loan was originated.
- While many lenders will consider allowing the buyer to cancel PMI when the value of the property rises so that the 80% loan to value ratio is achieved, they are under no obligation to do so. In my experience, the lender required that I pay for an appraisal done by an appraisal company selected by the lender. Also, the borrower must usually provide proof there is no second mortgage on the property. Cancellation may require a waiting period and a good payment history.
- The lender can purchase PMI, for which they pay the premiums, without notifying the borrower. Funds for these premiums may come indirectly from the borrower in points or increased interest.
PMI premiums are not insignificant. I looked at a loan statement for one of my recent investment properties. On a loan of approximately $200,000, the monthly principal and interest payment was $1,124.93. The monthly PMI was $163.53, or 15% of the P&I. Yet I never knew how much insurance this was buying or from whom. Had I carried this property the 10 or so years requried to reduce the mortgage balance to 78% of the purchase price, I would have paid over $19,000 in PMI premiums (nearly 10% of the original loan amount).
In the many recent articles on the subject, borrowers are urged to contact their lenders immediately when they run into financial trouble or feel they will be unable to keep their mortgage payments current. They stress that working out an arrangement with your lender is far better than going through foreclosure. Even if foreclosure is inevitable, industry sages recommend working with the lender to facilitate a "short sale," where the selling price is less than the mortgage amount, thus avoiding the stigma of a foreclosure.
Do you think the fact that the lender is protected with a PMI policy will make them more or less likely to work with the borrower? Why would they offer the buyer extended or more favorable terms or allow a short sale when they need only foreclose to collect their insurance? Isn't it ironic? You could have paid thousands for coverage that helped pit your lender against your best interests. "A banker is someone who will loan you an umbrella, but who wants it back when it rains," said my father.
Toby Tobin is Editor & Publisher of GoToby.com, the popular real estate news, information, and analysis website for the City of Palm Coast, Flagler County and Northeast Florida
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