Mortgage Insurance (PMI, MMI, etc) Explained

Westcoe Realtors, Riverside California…As almost anyone knows who has ever bought a home, the cash needed to make your purchase falls into 2 categories….the down payment, and the closing costs.  The down payment is relatively simple….it is your instant equity in the home, as it represents the difference between what the bank will lend you and the sales price. 

However, closing costs are another animal all together, since it seems everyone has their finger in your wallet…which isn’t far from the truth.  But instead of tackling all the players in the “get your cash home buying game,” today we will attempt to explain about only one of them…mortgage insurance.

To begin, please understand that mortgage insurance has nothing to do with insuring your home, like Allstate, Farmers, etc.  You are still going to need that insurance, since it protects your home against damage…like from a fire, water, tree falling, etc.

Mortgage insurance is different from homeowners insurance.   Mortgage insurance still offers protection, but not to you or your home….it’s for the bank who made the loan on your purchase.  In essence, mortgage insurance protects the bank from loss in case you, the new borrower, fails to make your payments, and the bank has to foreclose.  If the bank indeed finds it necessary to foreclose, then they will look to the mortgage insurance company to pay some of what the bank has lost on the home.

The irony with mortgage insurance is that the bank requires it, it protects only the bank, but YOU get to pay for it!  Nice racket when you think about it.

So…when is mortgage insurance required by the bank?  Well…it is on all government loans (FHA. VA), and is required on any conventional loan when the down payment is less than 20% of the sales price…but it’s paid differently with each type of loan.

On a government loan, the actual payment and cost for the insurance is built into your loan amount. You never see it and there is no separate payment…it’s just part of your monthly payment.  Of course, it is fully disclosed to you in your closing costs (we can get a bit cynical from time to time, but no one is trying to hide if from you), it’s just that as a convenience, the monthly payment for the insurance is bundled into your house payment to make things easier with just one simple payment.

On conventional loans, it is a bit different.  If you are getting a conventional loan and have a down payment of less than 20%, two things are going to be required by the new lender.  The first is that your monthly payment will include an estimated payment for your property taxes and homeowners insurance.  This is called an impound account (If you had 20% or more down, you could either have an impound account, or pay your property taxes and homeowners insurance separately…your choice).  The second requirement the new lender will have is that you obtain mortgage insurance.

The mandated mortgage insurance is usually called PMI, which stands for Private Mortgage Insurance.  There are other names (MMI…Mutual Mortgage Insurance), but it all represents the same thing…an insurance policy required by the lender, protecting the lender, but paid for by you.  The lenders rationale is that having this insurance policy allows the lender to make loans with the higher risk of loss that comes with a lower down payment…and maybe that is the case.  Or perhaps (here comes the cynicism again) it’s a money making situation that the banks don’t want to see go away. 

If you have a conventional loan, and after a few years your home value has increased (remember those days when home prices went UP?) to the point that you now have at least 20%  equity, you can apply to get your PMI insurance requirement dropped, thereby saving yourself the monthly payment.  There are a few steps involved (check with your lender), but they are not bad, and definitely worth the process.  If you have a government loan…sorry…you are stuck with the policy and payments…they cannot be removed like they can with a conventional loan.

As a final note, that has almost nothing and everything to do with this type of insurance…anyone want to take a guess why the government spent more money bailing out AIG insurance than the banks and automakers combined?  Give up? 

AIG was the PMI/MMI carrier for the majority of loans made in our country that required mortgage insurance…and if they went down (so the theory goes), it would have taken almost every bank with it because there would have been no money for the banks when they went to make their mortgage insurance claim on the foreclosures.  We’ll leave the politics on “too big to fail” to someone else…but that is why our government gave so much money to a company most people had ever heard of.

So, in the end, we hope this clears up some of the fog that surrounds mortgage insurance.  Bottom line…you pay, the banks get the benefit, and maybe it makes it possible for you to purchase the home of your dreams…or it’s a rip-off.  We’ll let you make the call.  Either way, it’s here to stay.

Take care, and let us know if you have any questions you would like to see addressed on our blog.