Private Mortgage Insurance (or PMI) really gets a bad rap. A lot of people think about PMI the same way that they think about income taxes or that annoying service fee that companies like to charge—just another expense that we have to pay with no real benefit. Actually, the private mortgage insurance industry is a big reason why almost 7 out of every 10 Americans own their home.
Historically, mortgages with a higher loan-to-value ratio have a higher rate of default than loans with larger down payments. PMI is an insurance policy that protects the lender from the increased default risk of higher loan-to-value mortgages.
Before the Great Depression, the mortgage industry was very different than what we see today. Most lending was done on a local level at community banks and savings and loan institutions. Loans were offered with short terms (usually under 10 years) which didn’t fully amortize, so the borrower would either need to make a balloon payment or refinance the balance. The other key piece of home finance during this time was that loans typically didn’t exceed today's 75% loan-to-value ratio. A substantial down payment requirement meant that a lot of people couldn’t afford to purchase their first home until later in life (if ever).
After this era, the Federal Housing Administration (FHA) was created, and with that came higher loan-to-value mortgages. These federally insured mortgages greatly increased the funds available to home buyers. While FHA mortgages were a big step towards home finance as we know it today, it wasn’t without its faults.
Fast forward to the 1950’s. A man named Max Karl, frustrated with the speed that it took to federally insure a mortgage, founded the first modern private mortgage insurance company: the Mortgage Guaranty Insurance Corporation (MGIC). This insurance, with premiums that were typically passed along to the borrower, encouraged the formerly ultra conservative banks to finance greater than 80% of a home’s value. There were minor regulations at the state level, but since local banks did the bulk of the lending, the home finance industry was largely unchecked by government.
As the government became more involved in the mortgage industry (through Fannie Mae, Freddie Mac and Ginnie Mae), the mortgage insurers started to see more regulation. In 1998, the Homeowners Protection Act was passed into law. This law mandated that mortgage insurance policies can be cancelled once a homeowner reaches 20% equity in their home (at the homeowner’s request) and can never be collected once the borrower exceeds 22% equity.
Today’s mortgage insurance landscape is the most competitive that it has ever been. This means better rates and more flexible (and borrower friendly) programs than ever before. A good lender will do business with several mortgage insurers in order to ensure that their customers receive good options without paying too much.
Hopefully, this has helped put private mortgage insurance into a more positive light. If you are thinking about buying and have more questions about how PMI may impact your transaction, our loan officers would be happy to help!
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