PMI Making A Comeback

PMI-Private Mortgage Insurance-is making
a comeback

In the mortgage lending business, a loan that is 80% of the value
of the home is considered to be a normal risk for the lender and
is considered to be the industry standard.

If a borrower needs financing that is more than 80% of the value
of the home (loan-to-value, LTV), that would represent a higher
risk to the lender and would be considered if the borrower has
better qualifications and if the lender were to receive higher than
normal rates and fees to compensate themselves for the higher
risk, or if that higher risk could be passed along to another party.

Private Mortgage Insurance (PMI) was developed in an effort to
give the lenders a feeling of comfort that they were not taking an
undue risk, and still provide a means for borrowers to obtain
home financing without needing 20% down payment.

PMI provides insurance to the lender in the case of a default in
payments by the borrower which would result in a monetary
loss to the lender. The borrower will be the one who pays the
cost of the policy and the premiums are usually collected with
each monthly payment from the borrower.

Let's take a look at an example. Let's say that the borrower is
buying a home valued at $500,000. They are able to provide a
down payment of $50,000 and they have additional funds for their
closing costs and cash reserves after closing. They need to
finance $450,000 which is a 90% LTV.

In the past few years the most popular way to put his
transaction together was to create a first loan of $400,000
(80% LTV) and couple it with a second loan of $50,000 for a
combined LTV of 90%. This was preferred because the first
loan was at the industry standard of 80%, so it was acceptable
risk to the lender and did not require PMI and was offered at
competitive interest rates and fees. The second loan of the
additional 10% was where the lender was experiencing the
additional risk. Rates and fees were higher only on this portion
of the financing to reflect that higher risk to the lender. Also,
the mortgage market was eager to create these second loans
because investors could receive higher rates, property values
were increasing and mortgage defaults were not common.

I'm sure that you have been hearing and reading that more
recently property values have leveled off and diminished in some
areas, and that mortgage defaults have increased. This has led
to less willingness of the lenders to create these second loans,
especially where the combined LTV was at 100%. As the
availability of these second loans is diminishing, we are seeing
that lenders are more willing to create one loan and to reduce
their risk by using PMI again.

The way the transaction would be put together using PMI is by
the lender creating a loan of $450,000 (90% LTV). The interest
rate on the loan itself would be at competitive rates and fees,
but the borrower would be required to qualify for and provide a
PMI policy to the lender. The PMI company would charge a
premium based on the LTV, whether the loan is fixed-rate or
adjustable-rate, whether the borrower qualified by providing
full documentation or was using stated income. The cost of
this policy could be in the range of $200-$300 per month.

But, it is a lot less expensive than trying to save another
$50,000 and missing out on home ownership in the meantime.

PMI is currently tax-deductible for borrowers whose adjusted
gross income (AGI) is $100,000 or less, is partially deductible
for AGI between $100,000-$109,000, and loses its deductibility
for AGI above $109,000.

Some lenders may offer to charge a higher rate on the loan, and
to have the mortgage insurance paid by them. This will then
show as interest being paid by the borrower, not insurance
premium, and will increase the chances of tax deductibility
without concern over the AGI limitations.

As always, there are many nuances to be explored to make sure
that you are being well-served by the mortgage recommendation.
Be sure that you are getting complete information to make an
informed decision.