What is Private Mortgage Insurance (PMI)?

In an attempt to secure the housing finance system of borrowing and lending, PMIs play a major role in supporting cash flow in the housing sector. Insurance covers are becoming more specific in their objectives and this comes with a number of benefits. Private Mortgage Insurance just as the name suggests, refers to insurance on homes.

What is private mortgage insurance (PMI)?

To be more precise, PMI acts as a risk management tool that seeks to protect the lender that he does not lose their funds in the event that the borrower defaults from making payment to service their loans. When seeking private mortgage insurance, it is expected that the borrower had put down about 20% funding of the home’s value when it was being purchased. This means that the loan-to-value (LTV) percentage is about 80% in excess.

This helps borrowers obtain their mortgage sooner despite the inability to save as much money sooner. Private Mortgage Insurance is a monthly paid investment which is monitored until it is considered enough equity to get the borrower off as a high risk in the lenders books.

This insurance cover applies to conventional loans only. It will cost you between 0.25% and 2% reflective on the balance on your mortgage loan every year. This will depend on the initial down payment you issued as well as the loan term and your current credit score. Looking at the rates provided, they are determined by a few factors. The higher the risk the higher your rate will be. In addition, the amount you borrow will also reflect on the rate you will receive.

Characteristics of Private Mortgage Insurance

The smaller the down payment made by the borrower, the more the risk they are to the lender. It is the role of Private Mortgage Insurance to mitigate the risk of losing funds in the event that borrowers default from payment. In this, PMI allows investors, loan purchasers and lenders secure on the funding then provide it to borrowers. This works by shifting part of the risk to a third party that seeks to manage the possible risk in the long-term. There are basically four forms PMI will take. These include:

Flow insurance

In reference to flow insurance, PMI will provide coverage based on the individual’s loan basis. This will be purchased at the time when the borrower takes on the loan. The borrower applies for a mortgage which will cover a certain percentage of the value of the home, he may be required by the lender to have the loan covered by Private Mortgage Insurance. Though the lender will select the PMI Company, the costs will be reflected to the borrower. In this, the lender will recover in the event that the borrower defaults from the agreement between them and the lender. The private mortgage insurance will step in for the borrower thereby making the payment which in turn acts like a cushion to fall on for the lender.

Bulk insurance

In reference to bulk insurance, the insurer will agree to provide coverage to each of the loans in a larger group of a number of loans which have been generally originated. It may be possible that these loans in this group have flow insurance especially if the loan is of high loan-to-value. In this case, the bulk insurance offers a second cover. In this case, it covers the aspects the flow insurance will not as covered.

Pool insurance

In reference to pool insurance, this cover looks at proving an insurance cover for a number of mortgages. These mortgages are aggregated for the sole purpose of calculating coverage and claims. Pool insurance will be provided by PMIs for mortgage securitizations.

Reinsurance

In reference to reinsurance, the lender or investor will pass part of the risk to a third party insurer. This link also seeks to reduce the risk by sharing it amongst another party.

Regulation pf Private Mortgage Insurance

Depending on your state, you will notice that different PMIs have different regulations. The different states will limit the capabilities of the given PMI to take on a given risk. They will be provided with restrictions such as:

Contingency reserve requirements
Capital requirements
Investment restrictions
Risk concentration restrictions
Countercyclical regulatory capital requirement

The two distinctive regulations that apply for the PMIs in comparison to other regulations on financial institutions, are the contingency reserve requirements and the countercyclical regulatory capital requirement.

Contingency reserve requirements provide for a greater part of cutting on losses as compared to the other regulations. These requirements address the potential risk by ensuring that all PMI companies have about 50% of the premiums in their reserve for a period of 10 years. This acts as a cushion in the event that there are large defaults by borrowers. This was as a result of the impact of the depression-era which led to the collapse of quite a number of financial institutions which provided private mortgage insurance services.

Having understood the operations of the Private Mortgage Insurance, you need to keep track of your payment to this third party while looking at the mortgage principal. Once you attain the 20% equity, it is advisable that you notify the lender so that they can discontinue the PMI premiums. You can make the notification in writing. The lender also has the responsibility of notifying the borrower the time period it will take to complete the 20% of the principle.

You can also opt to request that your premium be canceled in the event that your equity grows to 20% when the home’s price appreciates in value. Also, if you are able to make additional principal payments, you can also request that the premiums be canceled as long as you have a good history on your lending habits and you are not paying any other mortgage.

Private mortgage insurance comes in handy to protect your home after taking a mortgage while at the same time, the lender stands to benefit in the event that you default from making payment for one reason or another as long as the borrower is within the provided regulations.