Understanding Private Mortgage Insurance...You're not the one with coverage

I do a lot of short sales and a common question I get from clients is "I have Private Mortgage Insurance (PMI) so they cover me if I default right?"

Wrong.

The PMI policy on a loan covers the lender not the borrower. You're just the lucky one who gets to foot the premiums on the policy they take out on your loan.

Any easier way to understand this would be to relate it to car insurance. Say you've just gone down and traded in your clunker to take advantage of the government's latest program (I'll leave my opinion on this program out for the purposes of this discussion). The first thing you're going to do is call your agent and insure that shiny new ride.

Of course, since you have a loan on the car you're going to get full coverage insurance; and if you're in an accident and the other driver isn't insured your policy pays the bill. So there you are, and through no fault of your own, an uninsured driver is texting and driving (probably why they're uninsured in the first place) and doesn't stop in time to avoid rear ending your pristine new car. Once your insurance company pays for all the damages less your deductible they're going to sue the uninsured driver for the money they paid on your claim.

In the case of private mortgage insurance, you're the "uninsured driver." Your lender is protected because they're the ones with "full coverage" and not at fault in the accident (your defaulted mortgage). The only difference (besides whiplash) is, in this case, you the "uninsured driver", are responsible for paying for the bill every month incase you default.

That's private mortgage insurance in a nutshell for you.