Most Americans who pay for private mortgage insurance very month, also called PMI, do not like paying for it. PMI protects the lender against loan default for those who put down less than 20% when they bought the home. For most mortgage insurance companies, providing PMI is a very profitable business indeed.
Mortgage insurance premiums are pooled each month, very much like car insurance. They are then paid out to lenders who suffer a loss because of a home foreclosure. The amount of your PMI payment is rolled into the monthly payment on your mortgage. But it also can be collected every year, and even included in the interest rate to effectively mask the payment you are making.
Many experts in the mortgage industry think that mortgage insurance lenders are making too large profits these days. Also, they believe that lender paid mortgage insurance is especially devious; the interest rate you pay on the loan is effectively hiding what mortgage insurance costs you. Some people do not even know they are paying for PMI at all.
However, others point out that mortgage insurance companies do provide a legitimate service to Americans and to the housing industry as a whole. Mortgage insurance companies provide stimulus to the US housing market by reducing the risk for lenders to lend mortgage funds at over 80% LTV. This part of the market would largely dry up if mortgage insurance companies were not there.
Mortgage insurance is especially costly for borrowers with lower credit scores and lower down payments. For example, FHA loans are available to borrowers with only a 580-credit score, with a mere 3.5% down payment possible. These borrowers represent a higher risk for lenders, so it makes sense that this mortgage insurance will be more expensive and the company’s profits higher.
Just as with any insurance, profits happen when revenues are higher than pay outs. This was the case during the housing boom. But when the crash occurred, many mortgage insurance companies took a major hit. These days as of 2018, foreclosures are down, and the economy is relatively strong. So, mortgage insurance company profits are higher.
How PMI Works on the Lending Side
When a homeowner cannot pay his mortgage, the home will usually go into foreclosure. This will usually occur once the borrower is at least 90 days behind. In some cases, the lender may take the deed to the home in lieu of foreclosure. But for most cases, the home will go to auction. Other parties can bid for the property, but banks will usually bid whatever is owed and buy the home. With a conventional loan, the bank will then list the home to be sold. If it cannot be sold for at least the principal remaining on the home, the mortgage insurance company pays the difference. For instance, if the mortgage balance is $183,000 and the property auctions for $160,000, the insurance company pays the bank the difference of $23,000.
The same thing occurs for most government guaranteed loans, such as FHA. For instance, say that a home owner makes a 3% down payment on a $200,000 house and defaults after three years. There is $190,000 of the loan left to be paid. FHA will pay the bank that gave the loan $190,000. In a few cases, FHA will assume the property and try to recover as much as it can when the property is sold.
The Bright Side of PMI
Most Americans unite in their hatred of PMI and the profits that mortgage insurance companies make. But data shows that over time, paying PMI each month can be a good investment for homeowners. Paying for PMI means you will probably buy a home years sooner than you otherwise would have. According to the house price index at FHFA, home prices have gone up 3.5% each year since 1991.
In recent times, home prices have been going up 5% per year or more in many markets. By paying for PMI each month, you are making payments toward your future wealth. Each time you make a payment on your home, you are paying off a small part of the equity. PMI plays an important role here because it allows you to start building equity faster.
Also, many home owners find that they are able to cancel PMI after five or seven years. At this point, they have paid enough on their home to reach 20% equity. Or, they have enjoyed enough home appreciation through market forces to reach 20% equity. For many of them, the home may have appreciated at least 5% per year for several years, giving them tens of thousands of dollars in equity, while they only paid $5,000 or $10,000 in PMI payments. This is a good return on investment.
So, if you are upset about PMI company profits, we hear you, but in some circumstances, paying for PMI is not really a bad thing.
References: https://patch.com/california/lajolla/bp–are-mortgage-insurance-companies-set-to-earn-huge-profits & https://www.housingwire.com/articles/41669-mortgage-insurance-companies-struggle-to-keep-up-in-third-quarter