Private mortgage insurance allows you to buy a home with less than a 20 percent down payment. Conventional financing requires that you put 20 percent down, otherwise your mortgage is considered higher risk to the lender. PMI protects the lender against the possibility of default. It is an added cost for your loan, but allows you to buy a home with much less money out of pocket. While there are different forms and ways to structure PMI, the only variation from bank to bank will come from the third-party insurers they are using, not from the bank itself. Legally, banks cannot charge you more for mortgage insurance than they are being charged by the insurer.
Costs and Risk Factors
Private mortgage insurance companies are like any insurer. They set costs based on default rates, which can change over time. Their premiums are also tiered based on risk factors, such as the your loan amount relative to your purchase price, and credit score. For example, if your down payment is only 5 percent, you will pay more for PMI than if your down payment is 15 percent. Premiums will vary slightly from company to company, but they all follow the same principles.
Compare Different Programs
The most common way to pay PMI is to include it in the monthly mortgage payment. PMI companies also offer an option for paying it upfront as a lump sum. But lenders don't always offer this option upfront. The reason might simply be that the bank does not make as large a profit on one program versus another. Ask your lender about all your options and to compare rates between different insurers. Just because the lender has a relationship with one vendor or makes more profit on a certain program, that doesn’t mean it is the best option for you.
Lender Paid PMI
Some lenders offer “lender paid” PMI. They pay the insurance on your behalf, either as a lump sum at closing, or ongoing monthly, and then pass the cost on to you as a higher rate. This can be a great option for buyers who do not plan to hold the mortgage more than a few years -- a higher rate doesn't hurt you very much if you will pay off your loan in only two or three years. However, you need to understand that you are still paying your lender to insure against your default, only indirectly. The advantage of paying PMI as part of your monthly payment is that it can be removed when you reach a certain loan-to-value ratio (80 percent, 78 percent or 75 percent depending on the loan program). If you opted for lender paid PMI, you will not have this opportunity.
FHA loans provide another option for financing a home with less than 20 percent down, especially for those with less than perfect credit. FHA mortgage insurance premiums have a base rate considerably higher than for conventional loans, but it is not tiered by risk factor. FHA interest rates are also often lower than conventional loan rates, softening the blow of the higher PMI premium.
With more than a decade of experience, Gregory Erich Phillips is a trusted expert on real estate and mortgage financing. As an author, Phillips is known for his writings on economics, personal finance, religion, politics and culture.