Course 5 – Unit 2: When Is Private Mortgage Insurance Required

Private mortgage insurance (PMI) is required when a conventional home loan is used to purchase or refinance a house and, the borrower makes a down payment of less than twenty percent, or has less than 20 percent equity in the home.

Conventional loans are loans which are backed by Fannie Mae or Freddie Mac and they are available via all major lenders including Wells Fargo, Bank of America, Quicken, JPMorgan Chase, and others.

PMI is insurance for the lender, paid by the homeowner. It is the homeowner’s insuring of the lender against its own default. Should the homeowner should ever stop paying on its mortgage, the insurance policy get “cashed”, and the bank gets paid for its losses.

To understand why conventional loans required PMI when the down payment/equity in the home is less than twenty percent, consider what happens during a mortgage default. When a mortgage default occurs, the homeowner has stopped making payments on the home and at least 3 consecutive payments have been missed, which creates a loss for the lender (bank.)

Often, state laws delay the eviction, so it can be two years or more before a lender can re-claim a home. During this time, the home may have incurred damage from fire, flood, or neglect; and may be showing the effects of deferred maintenance. Deferred maintenance items include roofing issues, structural damage, and the presence of mold, as examples. By the time the home is eventually sold in foreclosure, the lender has likely incurred a real loss in terms of missed payments; plus, other losses related to home repair.

A lender will typically lose twenty percent of a home’s value during the process of default and foreclosure, which explains the requirement to put 20% down to avoid paying mortgage insurance. Putting down anything less than 20% puts the lender at risk in the case of a default as in the scenario described above.

Private mortgage insurance covers lenders against loss. The less you put down for a downpayment on a conventional loan the larger your mortgage insurance policy will be.

The lone exception is the HomeReady™ home loan, which allows for just 3% down. HomeReady™ offers discounted private mortgage insurance rates to match its discounted mortgage rates.