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Why Is Private Mortgage Insurance Important?

Jul 18, 2008
If you are considering buying a new home, then you may already know that there are many requirements that potential home buyers must meet. One such requirement is private mortgage insurance.

Private mortgage insurance, or PMI as it is commonly called, is a form of insurance that is designed to provide protection for the lender against non-payment, should the borrower default on a mortgage loan. The primary benefactor of mortgage insurance is the lender. There are no protections afforded to the borrower with these kinds of policies. You should understand that when you purchase PMI coverage, you are paying premiums with every mortgage payment to protect your lender.

There is generally no choice about having this coverage as most lenders will require that you obtain private mortgage insurance. The main reason that this is mandatory involves the condition that does benefit you as the borrower: the low down payment on the mortgage. Naturally, there is a higher level of default risk when a mortgage loan is given with a low down payment, and that must be accounted for and secured against on the part of lender.

Additionally, private mortgage insurance gives mortgage companies the ability to offer loans that in other cases would be considered too risky to be purchased by third party investors, such as Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). Retaining the ability to sell loans to these investing companies is important to lenders because it plays an important role in maintaining the liquidity of the mortgage market, which furnishes mortgage companies with the funds to create new loans for additional home buyers.

Needless to say, private mortgage insurance is not a popular form of insurance to buy, since it has no inherent value for the one purchasing it. Again, the lender will be the beneficiary of PMI, not you as the buyer. Yet, it is a necessary part of brokering a mortgage deal, to supply you with the financing to get that house you want. This type of insurance removes the obstacle of paying the prohibitively high down-payment amounts that most loans require. After all, who can come up with the 20% all at once? Most home buyers can't. Private mortgage insurance allows you to pay as little 0-5% down payment on a new home.

In conclusion, mortgage loans exist to provide more people with the opportunity to own their own homes. Yet lenders have interests that they need to secure when they take enormous risks by providing financial assistance to multiple borrowers. This is where the private mortgage insurance comes into play in modern mortgage loan agreements.
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