Private Mortgage Insurance (PMI) is used then a buyer has less then the typical 20% down or maybe has the 20% down but there are risk factors in their application. Risk factors could include inconsistent income history, previous credit events (repo, charge offs, medical bills) or other concerns the loan company may have.
When a borrower uses FHA or VA, the government (or an agency there of) acts as the insurer on a portion of the loan. The bank is still taking a risk of normally about 80% of the loan. If the borrower/buyer only put down 3.5% (FHA) then the FHA is providing approximately 17.5% of ‘coverage’ if the borrower defaults. In this example, the borrower is out 3.5% and the FHA is covering 17.5% leaving the bank responsible for 80%, but the bank will get the property and can sell it to hopefully recover their money.
When a borrower does not qualify for FHA or VA insured loans, but may have a solid credit profile and sufficient income, yet not enough down payment, the loan company may still approve the loan if the borrower pays for Private Mortgage Insurance. It is referred to as Private because it is a non-government business that is providing the coverage. Seldom is PMI cheap, and the cost is added to the monthly payment. However, the net payment including PITI and PMI minus tax credits could still be less then rental payments – and the buyer is still getting appreciate credit and the joy of home ownership.
Not all lenders will work with PMI and programs from lender to lender that does can have considerable variations in initial fees and total costs.
If you are looking at using a PMI insured loan – do lots of shopping around and lots of reading of the fine print.