Pvt. mortgage insurance or PMI is the insurance that you usually have to pay to the mortgage lender if you are making a down payment of less than 20%.
Pvt. mortgage insurance protects the lender against default by the borrower and covers his losses for the entire foreclosure proceedings . Lenders mostly suffer loss when they have to undergo foreclosure to recover the money that they have lent to the borrower. This is because sometimes the equity remaining in the house is less than the amount owed on the mortgage as well as due to the costs of the foreclosure proceedings.
It is called private mortgage insurance because it is funded by private insurance companies. As mentioned before government agencies like the FHA and VA insured loans given out by their approved lenders. This accounts for almost 20% of the mortgage market. For the remaining 80% of mortgage loans, it is private insurance companies that insure the amount for the mortgage lender.
If you are making less than 20% cash down payment on the mortgage you are an additional risk to the lender. In this case he will make it a mandatory for you to purchase PMI as well. There is usually no option to avoid this has almost all vendors follow this rule.
Pvt. mortgage insurance makes sense to the lender because they believe that for a person who has made less than 20% down payment is more liable to walk away from the investment in the property when things get tough. The person may face financial difficulties in the future, fail to make payments and to make matters worse a recession might cause the property values to drop. In this case the mortgage lender will not be able to recover the money owed on the mortgage through the foreclosure process. Foreclosure means paying Real Estate Commission, property transfer tax and other customary expenses associated with the resale of the house. All this will make it hard for the lender to recover the money he has lost. In fact, this is exactly what happened to many mortgage lenders when the real estate market slumped in the late 2000.
You may be able to deduct your PMI premiums on your federal tax returns.
How much do you have to spend on the PMI
The amount that the private mortgage insurance costs you depends on several factors:
Type of loan
ARMs will generally have a higher private mortgage insurance premium than FRM’s.
Read more: How Much Does A PMI Cost