What is Private Mortgage Insurance (PMI)?
Aside from inexperienced Agents, Private Mortgage Insurance or PMI is the second most common explanation of failed short sale attempts by home sellers and their agents.Â In order to understand PMI and how it affects the course of a short sale it is good to know why PMI exists.Â
When a lending institution wants to lend money it is common for them to request at least 20% for a down payment- this will provide them with piece of mind that if the new homeowner defaults on their loan there should be at least 20% equity minus fees and commissions at auction or REO.Â This is assuming market value is increasing as it was during the market upswing of the late 90â€™s through 2007.Â If a buyer did not have enough for a large down payment then they had the option of obtaining two loans, the first at 80% of the value of the home and the second at either 10% or if allowed 20% of the value; requiring no down payment whatsoever.Â Â
In short, PMI is used when a borrower has less than 20% for a down payment at time of purchase and does not take out a second loan to cover the down payment.Â In some cases, second loans have had PMI however it is not as common.Â
Like all insurance the borrower would pay a monthly premium either as a separate charge on their mortgage coupon, or the insurance was incorporated through a higher interest rate for the borrower.Â Many times this second form of PMI which was incorporated inside the borrowerâ€™s interest rate led the borrower to believe that no such insurance ever existed as it was never disclosed by their lender or broker.Â
How does PMI affect short sales?
Typically, if the borrower defaults on their loan the insurance company agrees to pay the lender a certain amount of money towards the losses.Â The number can vary depending on the type of insurance; however it is usually 17-25% of the loan amount.Â Â These monies would be paid to the lender on top of whatever other monies are collected through REO or auction.Â
Let us assume we have a $200,000 loan for a property that was purchased in 2006 for $205,000.Â Naturally the property dropped in value since the initial purchase and it is now worth about $90,000.Â This is very typically in single family homes in Oakland. Â Assume it costs about 8% to sell the property directly from the lender as an REO or short sale.Â Â
How much will the lender receive from the insurance company if the home is sold?Â
$200,000 times .20= $40,000
What price must the lender sell for not have a loss? Â
The lender's exposure has been limited to $160,000 now that they received $40,000 from the mortgage insurance company.Â We take $160,000 divided by 92% (remember that it costs 8% to sell so the 92% represents the net proceeds). Â Â $160,000/.92= $174,000.
In other words, in order for the lender to not lose money on this transaction they must bring an offer of at least $174,000 on a property worth roughly $90,000.Â
Of course we all know this will never happen.Â So now what?
Each lender has an agreement with the PMI Company which sets rules based on parameters that are set for each loan.Â The lender and the PMI Company both agree that they cannot sell a home worth $90,000 for $174,000 therefore they create a specific loss variance to still allow the lender to approve the sale of the home.Â To the extent the short sale will result in a loss under the pre-approved ratios, the lender can negotiate and approve the sale on its own. If, however the loss is too great and not within the loss ratio set forth by the PMI Company, the lender will require input from the PMI Company and therefore the negotiator at that lender must hand over the file for PMI review and approval.Â
Most PMI companies will take into consideration the overall property value, condition, loan amount and sellerâ€™s circumstances. The PMI Company will then either approve or disapprove the short sale and cover the percentage of the loss it insured for the borrower to the lender. In many cases the PMI Company will request the seller to come in with cash at closing or sign an unsecured promissory note for some of the loss.Â Ultimately if the short sale transaction involves PMI and the loss is great, that company has the decision for approval contingent on the seller coming in with cash or signing a promissory note.Â In certain states where it is allowed such as Nevada, if the borrower does not agree to the terms of the short sale and lets the home go into foreclosure the PMI company can file a judgment against the borrower.Â Â
Recently PMI Companies are extremely hard to come by and the very few left are being extremely picky on which borrowers they will support with PMI.Â Most have failed as have many banks and they have sold whatever remaining notes they hold to 3rd party companies which negotiate on their behalf.Â
Fortunately for many first time homebuyers FHA does allow small down payment programs with the help of a Government backed insurance.Â FHA is a great program for many borrowers which can qualify for it and I will address FHA at a later time.
Â If you have any short sale stories you would like to share about PMI please reply as I would love to hear them.Â