Private mortgage insurance (PMI) is a type of insurance that protects lenders if they stop paying a mortgage. It’s not designed to protect you, the homeowner.
Lenders typically require a PMI on a traditional loan if the down payment is less than 20% of the home’s purchase price. PMIs can make homeownership more accessible by allowing you to purchase your home with less upfront investments, but it’s important to remember to add a monthly mortgage fee. Whether you’re buying a home in competitive markets like Denver or the bustling city of Dallas, there are other strategic options to explore to avoid paying private mortgage insurance.
How to avoid PMI when buying a house?
1. Create a down payment of 20% or more
This is the easiest way to avoid PMI. If you can beat more than 20% of your home’s purchase price, lenders usually don’t need PMI as there is more fairness in the home from the start. This reduces the risk. However, savings like this can be a major challenge for many individuals, especially first-time home buyers.
Tips for saving bigger down payments:
Budgeting and Auto Savings: Create a strict budget and set up automatic transfers from checks to dedicated savings accounts for down payments. Reduce costs: Look for areas where you can reduce your spending, such as eating out, canceling unused subscriptions, or reducing discretionary purchases. Take advantage of tax refunds: Instead of spraying, put your tax refund directly into the down payment fund. Consider gifts: If your family and friends are happy to help, the gift can boost your down payment. Please note that lenders will need a gift letter to ensure that the funds are actually gifts and not loans. Down payment support programs: Research status and local programs, particularly for first-time home buyers or people within a particular income group. These can offer grants or low interest rate loans. 401(k) Loan or withdrawal: While generally not recommended as the first option due to potential penalties and impact on retirement savings, some plans allow borrowing or withdrawal to buy a home. Please consult your financial advisor about this.
2. “Piggyback” Second Mortgage (10/10/80)
This strategy involves taking two loans at the same time.
First mortgage of 80% of the home’s value. A portion of the remaining amount, usually a second mortgage of 10% (often a credit or HELOC home equity line). After that, you will create a 10% cash down payment.
This structure is known as the 80/10/10 loan (80% first mortgage, 10% mortgage, 10% down payment). Avoid PMI on that major loan as your first mortgage has an 80% loan to value (LTV) ratio.
Pros of piggyback loans:
Avoid PMI. You can purchase it for less than 20%. The second mortgage (HELOC) allows you to pay back faster and release your funds.
Cons of piggyback loans:
You will receive two mortgage payments per month. The interest rate on the second mortgage is often higher than the first mortgage and can be adjustable (variable). You may incur closure costs for both loans. Eligibility for two loans is more complicated and may require a higher credit score.
3. Lending Mortgage Insurance (LPMI)
With LPMI, the lender is that you pay the mortgage premium instead of paying it directly. In exchange, lenders typically charge slightly higher interest rates on mortgages.
Pros of LPMI:
There are no individual monthly PMI payments. Compared to PMI paid by borrowers, the monthly out-of-pocket amount may be lower.
Cons of LPMI:
Higher interest rates continue for the life of the loan (unless you refinanced) even after you have built up important equity. With traditional PMI, once you reach 20-22% of stock, you can usually delete it. In the long run, LPMI will be more expensive than traditional PMIs.
4. VA Loans (for eligible Veterans and Service Members)
If you are a qualified veteran, active service member, or surviving spouse, VA loans are a great option. VA loans are supported by the U.S. Department of Veterans Affairs and offer great benefits.
In most cases, no down payment is required. There is no mortgage insurance (PMI) at all. Often comes with competitive interest rates.
5. USDA Loans (for eligible country home buyers)
The USDA provides loans to low- and middle-income home buyers in eligible rural areas. Additionally, these loans typically do not require a down payment and offer lower mortgage insurance costs compared to traditional or FHA loans.
Other considerations:
FHA Loans: FHA loans are popular for lower payments (just as low as 3.5%), but always require a mortgage premium (MIP), which consists of both prepaid premiums and annual premiums. With most FHA loans, this MIP is the life of the loan, unlike traditional PMIs that can be removed. If your main goal is to avoid mortgage insurance, FHA loans are generally not the solution.
Before making a decision, it is important to compare the long-term costs of each option with a qualified mortgage lender to see which is best suited to your financial situation and homeownership goals.
How to remove private mortgage insurance (PMI)
Many homeowners pay private mortgage insurance (PMI) as part of their monthly mortgage payments, but did you know that they might be able to remove it? Fannie May, a leading player in the mortgage market, outlines how this works.
When can I request to delete my PMI?
Once the loan servicer reaches 80% of the original value of your home, the loan servicer can request that you terminate the PMI. When you bought your home, your lender provided you with a depreciation schedule. This schedule is shown accurately when the loan balance is projected to reach that 80% mark. Be aware of this date and the progress of the loan, as you will often be entitled to remove your PMI.
Automatic PMI end
Without requesting, the PMI could automatically end when the loan balance reaches 78% of the original value of the home. However, to avoid paying more than necessary, it is best to contact the loan servicer as soon as the balance reaches 80% to see if you qualify for early termination.
Requests termination based on current home value
If the value of your home has increased significantly since you purchased it, you may be able to remove the PMI faster based on its current market value. To explore this option, contact your loan servicer to discuss specific requirements and the process of terminating PMI based on increased home capital.
How much is the PMI?
Like other types of insurance, PMI fees may change daily. So, how do you figure out what you might pay?
Here’s how to calculate the estimated PMI:
Calculate your annual PMI: Multiply the total loan amount by the current PMI rate (don’t forget to convert the percentage to a decimal point). Calculate your monthly PMI: Get that annual PMI amount and divide it by 12. This will give you an estimated monthly PMI payment.
Examples of private mortgage insurance
Let’s take these numbers as an example. Imagine buying a $400,000 home. The loan amount is $400,000. Here’s how it breaks down when the PMI rate is 0.75%:
Annual PMI: $400,000 multiplied by 0.0075 (0.75% decimal equivalent) to $3,000. Monthly PMI: Dividing that annual amount by 12 months means paying PMI $250.00 per month.
This added monthly cost highlights why many home buyers are looking for ways to avoid PMI if possible.
Key takeout
PMI protects lenders. It’s not you. Private Mortgage Insurance (PMI) protects lenders by default on loans. This is usually required on a traditional loan if the down payment is less than 20% of the home’s purchase price. Multiple strategies to avoid PMI: A 20% down payment is the most direct route, but other options to bypass PMI include using a “piggyback” second mortgage (80/10/10 loan), taking into account lender wage insurance (LPMI), and taking professional loans such as VA loans (for appropriate service members) and USDA Loans (for adaptive Rural Home Buyers). PMI can be deleted after purchase. Even if you start with a PMI, you may be able to delete it later. You can request termination if your loan balance reaches 80% of your original home value or automatically ends at 78%. If your home’s value increases significantly, removal is also possible.
