Private Mortgage Insurance (PMI) is typically required when:
Audio Lesson
Duration: 2:37
Question & Answer
Review the question and all answer choices
The buyer has excellent credit
Credit quality affects interest rates and loan approval but doesn't determine PMI requirements. Even buyers with excellent credit may need PMI if they make a down payment below 20%.
The down payment is less than 20%
The property is commercial
Commercial properties typically have different financing requirements and don't use conventional residential PMI. This option confuses different property types and their financing structures.
The loan is from a private lender
The source of the loan (private lender vs. conventional) doesn't determine PMI requirements. PMI is based on the loan-to-value ratio, not the type of lender providing the financing.
Why is this correct?
PMI protects lenders when the loan-to-value ratio exceeds 80%, which occurs when the down payment is less than 20%. This is a standard industry practice to mitigate risk for lenders when borrowers have less equity in the property.
Deep Analysis
AI-powered in-depth explanation of this concept
Understanding PMI is crucial for real estate professionals as it directly impacts buyer affordability and transaction viability. This question tests your knowledge of when PMI is required, which is fundamental for guiding clients through financing options. The core concept revolves around loan-to-value (LTV) ratios. To arrive at the correct answer, you must recognize that PMI is a risk mitigation tool for lenders when borrowers have less skin in the game. Option B correctly identifies the 20% down payment threshold (80% LTV) as the determining factor. This question is challenging because it requires distinguishing between credit quality, property type, and lender type—factors that might seem relevant but don't actually determine PMI requirements. Understanding PMI connects to broader knowledge of mortgage financing, risk assessment in real estate, and how different loan programs work.
Knowledge Background
Essential context and foundational knowledge
Private Mortgage Insurance (PMI) is a type of insurance that protects lenders if a borrower defaults on a conventional mortgage. It emerged as a solution to allow homebuyers with less than 20% down payment to still qualify for loans. Before PMI, lenders typically required 20% down to mitigate their risk. PMI enables more people to enter the housing market by reducing lender risk. The Homeowners Protection Act of 1998 established rules for when PMI can be cancelled, requiring automatic termination when the loan balance reaches 78% of the original value.
Twenty down, PMI out; less than twenty, you'll have PMI in it.
Remember this simple rhyme to recall that PMI is required when the down payment is less than 20%
For PMI questions, focus on the down payment percentage or loan-to-value ratio. PMI is almost always tied to the 20% threshold, regardless of credit score or lender type.
Real World Application
How this concept applies in actual real estate practice
Sarah, a first-time homebuyer, found her dream home priced at $300,000. She had saved $45,000 for a down payment (15%). Her agent explained that because her down payment was less than 20%, she would need to pay PMI, which would add approximately $150 to her monthly payment. The agent helped Sarah understand that once her equity reached 20% (either through appreciation or additional payments), she could request to have the PMI removed, making her housing costs more affordable in the future.
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