If you do not have a 20% down payment to purchase the home, you will more than likely be subject to paying private mortgage insurance (PMI), which will be figured into your monthly mortgage payment.
PMI protects the lender in case you default on your loan and don’t have enough equity built up to sell the home and pay off the loan balance. Private mortgage insurers are for-profit companies that provide this protection for lenders.
Private mortgage insurance (PMI) is an extra mortgage cost that is used to cover the risk to a lender, and that is paid by a borrower in monthly premiums tied into their mortgage payments. It is not for the benefit of the borrower.
This type of insurance is usually required by lenders when a mortgage loan amount is above 80% loan to value (LTV) and the borrower has less than a 20% cash stake in the property. A loan amount above 80% is considered a lot riskier to lenders, and in order to cover this risk, they require insurance that will pay them in case the borrower defaults on the loan.
PMI payments range anywhere from 1% to as high as 1.5% of the loan amount that is amortized yearly and paid monthly throughout the life of their loan as long as the loan amount is above 80%.
For example, let’s say you get a $100,000 loan amount and are required to have mortgage insurance. Your estimated monthly insurance payments would be approximately $100 extra a month. A $200,000 loan amount would equate to approximately $200 a month in extra insurance fees.
As you can see, this money can add up quickly. Also, please keep in mind that this money does not help pay down the mortgage balance, and it is not tax-deductible.
You pay PMI as part of your monthly mortgage payment until you reach at least 20 percent equity in your home.
Because PMI exists for the benefit of the lender rather than the borrower, it would make perfect sense that most borrowers would be curious about either avoiding or canceling their PMI policies in order to save money on their monthly payments.
Although it is possible to eliminate the need to pay for PMI, the money required and process can be difficult for many people.
Here are a few ideas on how to avoid private mortgage insurance (PMI).
1. Make a 20% down payment
The most commonly known way to avoid private mortgage insurance altogether is to make a full 20% down payment when closing on your mortgage.
By putting 20% down, the lender knows you are a serious borrower who is placing a good chunk of money as a down-payment and they only have to extend an 80% loan, which makes it considerably less risky. This is also called an 80% loan to value.
Making anything below a 20% down payment automatically binds a borrower to a PMI plan.
However, having 20% down is easier said than done, and many borrowers are unable to meet this demand. This makes this specific method difficult for a lot of people.
2. Get a Second Mortgage
Another way to avoid the PMI policy would be to take on one of these funny-named loans, also known as “80-10-10” or “80-5-15” mortgages. The secret of this loan lies with the fact that it is actually two instead of one.
Although the thought of two separate loans on one mortgage plan might sound scary, they actually reduce the amount that you have to put down on a home while still avoiding PMI. Someone with just enough cash to make a 10% down payment is going to get a 90% mortgage and be stuck with a PMI premium.
Piggyback loans allow home buyers to take on one mortgage for 80% of the purchase price, and a second for 10% of the purchase price.
Under the program, the two loans make one mortgage at 90% of the purchase price, but act as two separate finance options. That 10% down payment under this program will suffice for the 80%-10%-10% plan, and could end up being even lower at 5% for the 80%-5%-15% plan.
Under this option, the 80% loan will not require PMI, and most lenders who hold this plan won’t require PMI under it due to the smaller lower-risk loans. Like everything else, piggybacks come with their downsides.
For example, the interest rate for the second loan will most likely be higher due to such a short term. While paying it off, you may end up paying a little extra in interest, all to save yourself from PMI.
3. Wait for your equity to rise above 20% loan to value
If you are currently paying mortgage insurance, the only way to cancel the insurance is to have more than 20% equity in your property. Some people will need to build equity over time if the housing markets allow them to eliminate their insurance policies. If your homes increase in value so you have 20% equity, then you can have the insurance canceled.
This will not happen automatically.
You have to call your mortgage servicers and have them review your mortgage and home value to assess if you can have the PMI requirement waived.
Please keep in mind that mortgage insurance is not an insurance policy to protect you in case you miss your monthly mortgage payments, but for the lender only. If you fall behind on your monthly payments and you have this type of insurance, you can still lose your home to foreclosure.
It is your lender who would benefit from the insurance because they would still be paid in full even if you stopped making mortgage payments altogether and/or if you were foreclosed on.
To see if you’ll be paying PMI, you can start by talking to your loan officer about the details of your loan. They’ll be able to look at the specifics and let you know the amount you will be paying.
Moe Bedard is the founder and lead mortgage analyst for LoanSafe.org. Since 2007, LoanSafe has helped over 2 million consumers with solutions to their mortgage problems and has been featured in the New York Times, LA Times, Fox Business, and many other media publications.