How Private Mortgage Insurance Cuts Real Estate Costs

The private mortgage insurance industry is doing well these days and that's good news for borrowers. The major private mortgage insurance companies all reported solid second-quarter profits and that's a result borrowers should celebrate.

You might be wondering, why should mortgage borrowers care about insurance companies? The answer has a lot to do with your ability to borrow cheaply.

When lenders originate mortgages, they will readily finance borrowers with 20 percent down. The obvious problem is that not every borrower has such cash. In June, for example, the typical existing home sold for $247,700 while the median price for a new house was $306,700. Twenty percent of these prices ranges from $49,540 to $61,340. And – don't forget – closing costs are extra.

If people really had to pay 20 percent up front with each and every home purchase, the real estate market would have no hope of either solid sales or rising prices. Fortunately, there is a way around the 20 percent barrier, the use of FHA, VA and private mortgage insurance, what's commonly called PMI.

By using a second-party insurance program, lenders have less risk – and when lenders have less risk, financing is available with less down and at a lower cost. As an example, following the 2007 financial meltdown, private mortgage insurance companies paid out $50 billion to lenders.

PMI companies can do this because they are regulated at the state level and no state wants unpaid mortgages, something which would reduce the availability of real estate financing. Also, mortgage insurance companies are "monoline" insurance firms. That means they are only allowed to sell one form of coverage; there are no surprise policies waiting to gobble reserves if they fail.

Private Mortgage Insurance vs the FHA

Most borrowers know about the FHA and VA programs, but PMI is something of a mystery.

The difference between FHA and PMI – the two most direct competitors – generally breaks down in several ways:

First, the minimum FHA down payment requirement is 3.5 percent. PMI has traditionally required 5 percent down, but financing with 3 percent down – a 97-percent loan-to-value mortgage – is increasingly available.

Second, FHA financing now requires a 1.75 percent up-front mortgage insurance premium. This sum is typically added to the mortgage amount, meaning the borrower does not have to bring extra cash to closing. However, a larger loan means a bigger monthly payment and more to pay-off when the house is sold or the loan is refinanced. Many PMI options do not require an up-front fee.

Third, depending on your credit score, the monthly insurance fee for PMI can be lower than with the FHA program.

Fourth, new FHA rules keep monthly insurance payments in place for the life of the loan for most borrowers. With private MI, it's possible to cancel in as little as two years, and sometimes even less. To cancel early you need to pay down the loan, an investment to consider given the minimal returns available today with CDs and savings accounts.

Lenders can tell you more about FHA and alternative programs backed by PMI. As you consider your options, ask these questions:

  • How much will it cost to settle with each program?
  • What is the up-front cost of each option?
  • What is the monthly payment for each program?
  • At what point can you can cancel insurance coverage given your down payment?
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