Private mortgage insurance, or PMI, is a type of insurance coverage designed to protect the mortgage lender from potential loss. Just about all loans for mortgages that involve less than a twenty percent down payment carry this type of insurance. In order to pay for the PMI, the premium is bundled into the amount owed by the borrower and covered in the monthly mortgage payment.
With many types of mortgage options, the terms and conditions include the borrower making a twenty percent down payment on the property that is being purchased. The loan then covers the remaining eighty percent. This standard arrangement of an 80/20 split is generally considered to be a lower risk arrangement for the lender. Even if the borrower were to default on the mortgage, the lender could gain control of the property and be highly likely to recoup the full amount of the loan. The chances of completely offsetting the loss when the mortgage covered a higher percentage of the purchase price are considerably lower, thus making the mortgage a riskier venture for the lender.
In order to protect the interests of the lender, PMI provides a means of offsetting the level of risk. The coverage is provided by a private insurance company; the actual premium may vary slightly, depending on the actual percentage of the down payment made by the borrower. Mortgage lenders are responsible for paying the premium to the underwriter, and usually pass along the cost of the monthly premium to the borrower. The PMI premium is bundled into the total mortgage payment made by the borrower each month.
Unlike some forms of insurance coverage, PMI is not tax deductible. The main advantage of this type of insurance is protecting the lender in the event that the borrower is unable to continue making the monthly mortgage payments. After seizing the title to the property and selling the property at the going rate, most PMI policies will then cover any expenses or outstanding balance remaining on the mortgage. This helps to ensure the lender will not incur a loss from the default or the cost of recovery.
PMI is very similar to the Mortgage Insurance Premium that is common when the borrower secures a FHA loan. In both cases, the lender is protected from situations where the borrower fails to comply with the terms and conditions of the mortgage, and prevents the lender from realizing any type of loss from the transaction.