Summer school: PMI
LISA NAPOLI: Now that may be true, but here at Marketplace Money, summer school is in session.
So far, our syllabus has covered the federal funds rates and earnings reports. This week, we focus on three little letters: PMI. We went to our local Home Depot to ask people what they thought it means.
MAN 1: I have no idea.
MAN 2: No, not at all.
MAN 3: Wow. I . . . primary, uh . . .
MAN 4: Some kind of insurance offered by a private contractor or a private company or a private organization?
MAN 5: Is this one of those things where I’m gonna look really dumb on the radio?
MULTIPLE PEOPLE: What is PMI?
NAPOLI: And now, for a real definition. At the blackboard today is Greg McBride of Bankrate.com.
GREG MCBRIDE: PMI stands for “private mortgage insurance.” And where this comes into play is if you’re buying a home or refinancing a mortgage and you don’t have much equity in the property, or you’re not making a large downpayment. This is an insurance policy that protects not the borrower, but the lender. Because you’re making a small downpayment, you represent higher risk to the lender. Therefore, they want to have an insurance policy that would protect them in the event that the borrower defaults.
There are alternatives to private mortgage insurance. One that’s been particularly popular in recent years is what’s known as a “piggyback loan.” A piggyback loan involves simultaneously taking two loans in lieu of making a larger downpayment. Many borrowers have gone this route in years past, but the dynamic is changing a little bit because of a recent provision in the tax code that makes private mortgage insurance premiums deductible for loans been issued to certain borrowers in 2007.
One thing to keep in mind with private mortgage insurance is that the smaller the downpayment you make, the higher the premium you will have to pay for that insurance. For example, if you’re buying a home for $100,000, and you don’t have a 20 percent, or $20,000 downpayment, you’re going to take a larger mortgage and subject yourself to private mortgage insurance. But if you’re borrowing $85,000, you’re going to have a lower premium than if you were, say, borrowing $95,000. That represents less risk to the lender. That lower risk means lower premiums on your private mortgage insurance.
NAPOLI: Our teacher this week was Greg McBride of Bankrate.com. More summer school next week, when we tackle that tricky concept known as “short-selling.”
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