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Private mortgage insurance, also known as PMI, protects a mortgage lender (such as a bank or credit union) from a loss in the event you default on your mortgage loan. Lenders purchase individual mortgage insurance policies for homeowners with loans for more than 80% of the value of their homes. The cost of the mortgage insurance premiums is then passed onto the borrower and added to their mortgage payment. Once 20% of the principal balance of a loan is paid off, or a borrower owns 20% of the equity of their home, borrowers are no longer considered a high default risk and can request that the mortgage insurance policy be cancelled. By law, mortgage lenders must cancel a mortgage insurance policy once a borrower has paid 22% of the balance of the loan.
Mortgage Insurance Basics
Most homeowners require a mortgage to purchase a home, but not every buyer is required to insure their purchase. Private lending institutions that offer mortgages use PMI to protect themselves from a loss in the event a borrower defaults on their loan. Generally, any mortgage with a loan-to-value ratio (LTV ratio) of 80% to 97% will require mortgage insurance. That means if a borrower can only make a down payment between 3% and 20% of the value of a home, their lender will require them to have a policy. The cost of the PMI premiums for the policy are then passed on to the respective borrower and included in their mortgage payment along with the principal, interest, homeowners insurance and property taxes.
Depending on your circumstances, your bank or mortgage lender may supply your private mortgage insurance itself, source it from another financial institution, or look to the Federal Housing Administration or the U.S. Department of Veteran Affairs.
The Federal Housing Administration (FHA), in an effort to qualify more people for home loans, provides mortgage insurance to approved lenders that offer mortgages to qualified borrowers. The policies function exactly like private mortgage insurance, except a government administration, not a private company, is selling the policy. Borrowers who qualify for the FHA insurance are still responsible for the cost of their mortgage insurance premiums.
The U.S. Department of Veteran Affairs also offers something like mortgage insurance to veterans. The department guarantees a portion of home loans obtained by eligible veterans to protect private lenders from incurring losses. The guarantee allows lenders to offer favorable loan terms to veterans, including no required down payment and no required mortgage insurance.
Mortgage Insurance vs. Mortgage Protection Insurance
Private mortgage insurance and mortgage protection insurance (also known as mortgage life insurance) are not the same thing. Mortgage life insurance is an insurance policy designed to pay off a policyholder's mortgage in the event of their death. Some borrowers might purchase a mortgage life insurance policy so their dependents can remain in the residence they have a mortgage loan for. What differentiates mortgage life insurance from traditional life insurance policies is that the death benefit is paid directly to the mortgage lender. Traditional life insurance policies pay the death benefit directly to the beneficiaries listed on a policy.
There are two types of mortgage life insurance: decreasing term and level term. Decreasing term policies pay out less as the the outstanding balance of a mortgage loan is paid off. The death benefit paid in level term policies does not change and is only beneficial to borrowers making interest-only payments toward the home they have a mortgage for. Most consumers forego mortgage life insurance policies altogether and choose to either purchase a traditional term life insurance policy, which is comparable in price and effectively serves the same purpose while providing more financial flexibility to beneficiaries.
The Mortgage Insurance Market
Mortgage insurance is a $1.79 billion portion of the insurance industry in the U.S. but compared to other lines of insurance, such as auto or homeowners insurance, there are not many companies that offer the policy. MGIC and Radian are monolines that together accounted for more than than 44% of the U.S. market share for direct premiums written in 2014.
The mortgage insurance market was heavily impacted by the housing collapse and recession in 2008. According to the Federal Insurance Office’s 2015 annual report on the insurance industry, approximately 40% of mortgage insurance participants failed as a result of the crisis and in 2010, only 4.3% of all new mortgage loans were insured by mortgage insurance. Since then, the mortgage insurance market has rebounded. In 2014, market rebounded and 14.8% or $176 billion of all mortgage originations were covered by a mortgage insurance policy.