A lender likes when the buyer puts down at least 20% towards the price of the home. They do not appreciate a high loan to value (LTV) ratio, certainly not one greater than 80%. This means that on a house appraised at $200,000, $40,000 is needed to put down before closing. If this is not possible, either the home cannot be purchased or mortgage insurance (PMI) needs to be purchased. The purpose of mortgage insurance is to insure the bank or lender against the buyer not paying and perhaps going into foreclosure. The buyer is paying to insure the bank’s risk in making the loan to someone who did not put down 20% of the purchase price of the home. If the buyer puts down at least 20%, the purchaser is said to have “skin in the game.”

Mortgage insurance rates can run as high as 3%. That would entail a payment of $1,500 for a $200,000 home. In the past the entire PMI was paid at closing. It has since changed and the insurance will run for the length of the loan. This gives the homeowner an incentive to end the payments. The PMI will be held in escrow. The amount will be added to other escrow items such as home insurance and taxes. when purchasing a home, these added costs must be considered along with the specific monthly mortgage payments.

If the homeowner puts more money into the home each month, the PMI can be stopped, when the equity in the home reaches 20%. If the house appreciates in price and the Loan to Value Ratio has gone down, the mortgage insurance can also be ended. The buyer will have to take the initiative in ending the mortgage insurance. There is no incentive for the bank to remind you that the insurance can be ended. After all, they are still getting additional insurance that the homeowner is paying for.

Private mortgage insurance, or PMI as it is commonly called, is a form of insurance that is designed to provide protection for the lender against non-payment, should the borrower default on a mortgage loan. The primary benefactor of mortgage insurance is the lender. There are no protections afforded to the borrower with these kinds of policies. You should understand that when you purchase PMI coverage, you are paying premiums with every mortgage payment to protect your lender.

There is generally no choice about having this coverage as most lenders will require that you obtain private mortgage insurance. The main reason that this is mandatory involves the condition that does benefit you as the borrower: the low down payment on the mortgage. Naturally, there is a higher level of default risk when a mortgage loan is given with a low down payment, and that must be accounted for and secured against on the part of lender.

Additionally, private mortgage insurance gives mortgage companies the ability to offer loans that in other cases would be considered too risky to be purchased by third party investors, such as Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). Retaining the ability to sell loans to these investing companies is important to lenders because it plays an important role in maintaining the liquidity of the mortgage market, which furnishes mortgage companies with the funds to create new loans for additional home buyers.

In conclusion, mortgage loans exist to provide more people with the opportunity to own their own homes. Yet lenders have interests that they need to secure when they take enormous risks by providing financial assistance to multiple borrowers. This is where the private mortgage insurance comes into play in modern mortgage loan agreements.