PMI enables homeowners to buy larger, more expensive homes.
Personal mortgage insurance, more often referred to as private mortgage insurance, or PMI, is frequently required on conventional and government-guaranteed loans when a homeowner puts less than 20 percent down. Lenders require this because studies show that homeowners who provide less than a 20 percent down payment are more likely to default on their mortgages. In the event of default, PMI pays the lender up to the insured mortgage amount.
Private Mortgage Insurance Defined
Private mortgage insurance is an insurance policy on residential mortgages that protects lenders against a borrower’s default. It is required by lenders, but usually paid for by homeowners. Private mortgage insurance protects the lender against losses in the event a homeowner stops making payments and defaults on the home and the home is foreclosed or given back.
PMI Benefits to Homeowners
PMI enables home buyers to purchase a more expensive home or purchase a home sooner than would be possible if they had to save a full 20 percent down payment. In
some cases, it makes it possible for a home buyer to put down as little as 3 or 5 percent. Private mortgage insurance allows home buyers who do have the savings to maintain those savings for other purposes and use additional leverage. This additional leverage increases financial risk but, if the home greatly appreciates, also increases the homeowner’s return on investment.
Foreclosure and Conventional
When a homeowner defaults and doesn't cure the default within an allowable time period, the home goes into foreclosure. In rare occasions the lender will take the deed on a house in a deed-in-lieu-of-foreclosure transaction. However, for most, the culmination to foreclosure is the auction. Although others can bid for the home, banks bid what is owed and usually get the home. With conventional loans, the bank will list the home for sale. If the home does not sell for at least the mortgage principal remaining, the mortgage insurance will pay the difference. For example, if the mortgage payable was $183,000 and the property sold for $160,000, the PMI will pay the bank the $23,000 difference.