If you make less than a 20% down payment on a home loan, you may have to take out Private Mortgage Insurance before being approved for the loan. Private Mortgage Insurance (PMI) is conditional protection that benefits lending institutions from the risk of defaulting on the loan or foreclosure of a house. It adds an extra expense to your monthly bills and can be very inconvenient if your financial situation improves.
However, not all hope is lost. Under the Homeowners Protection Act (1998), there is a laid-out process of canceling PMI as long as certain requirements are met, making it easier for borrowers (NCUA). But there are other ways to get around PMI.
This article helps you understand what PMI is and the types, along with how PMI is calculated. We will also discuss the variety of ways you can avoid paying PMI, or if that isn’t quite possible yet, ways to reduce the payment.
Understanding Private Mortgage Insurance
Private Mortgage Insurance (PMI) is a type of coverage that protects lenders if you are at-risk to default on your mortgage loan or liable for foreclosure. PMI is generally only required if the down payment is less than 20% of the loan value. How much you end up paying depends on your credit score and how much you put down. However, it’s not applicable to government-backed FHA and VA loans with low to zero down payments.
There are two types of PMI: borrower-paid and lender-paid. Opting for a borrower-paid approach means that you as the borrower will pay the PMI. If you want, you can go the lender-paid way–the lending institution will pay the PMI, but will roll over the cost of doing so into the interest rate for the life of the loan, which means you might end up paying more over time.
How is PMI calculated?
PMI is calculated based on how much of a down payment you made and your credit score. Your payment will be calculated on those factors initially. Every year, the PMI is recalculated based on how much remains on the loan. Which is a silver lining of sorts, knowing that the amount you pay will decrease over time.
Can you reduce or stop paying PMI?
Another way to reduce or stop PMI is when the loan-to-value (LTV) ratio is 80% or lower and the loan started on or after July 29, 1999 (when the Homeowners Protection Act began). However, the market value of your home may have fluctuated, so the lender may require a brokerage price opinion, which may disqualify you if your LTV is not 80% (source).
Once you, as the borrower, have enough equity built up, the PMI can be removed. If you want to refinance your loan, it can decrease or entirely eliminate the PMI coverage. This refinancing usually requires an appraisal, which determines the value of your home. Then you take that new market value and essentially create a new loan under those conditions. However, your credit score may still be a limitation on your ability to eliminate PMI.
Ways to avoid paying PMI
There are various ways you can get around having to pay for PMI. Some are easier to do than others. However, the important thing to remember is that some options may take time. You can expect to pay PMI for a good chunk of time before you can get out of it.
1. Make a 20% down payment.
For starters, the fastest and easiest way to avoid paying for PMI is to not have any, to begin with. If you put up 20% of the down payment, then there is no need to worry about paying for PMI. If you can’t make that percentage point, you can look into down payments assistance programs to see if you qualify, especially if you are a first-time homeowner.
2. Get a VA or FHA loan.
Making a down payment of 20% may not always be feasible, no matter how responsible you are fiscally. However, there are some down payment assistance programs through VA or FHA. These government agencies can help cover the costs of down payments, and some may not even be required to pay back. It is a good idea to speak to your lender to determine if you qualify for these monies.
3. Piggyback loans
Piggyback loans, or second mortgages, help decrease the LTV ratio. The second mortgage would cover the remainder of the loan above 80%. For example, you could do your first mortgage at 80%, the second mortgage to cover 10% and make a 10% down payment. A piggyback loan may seem counterproductive, but a second mortgage can be easier to pay off and eliminate than PMI.
4. Pay down current mortgage.
If there is no penalty for doing so, making higher payments or prepayments on your mortgage can be a quick way to get out of PMI. In terms of LTV ratio, this method decreases the loan compared to the value, making it easier to reach that 80% benchmark. The faster you can get your loan paid off, the faster you can get out of the PMI.
How not to pay PMI
Private Mortgage Insurance (PMI) serves no benefit to the buyer and can be a pain. Thankfully, the Homeowners Protection Act has made the process a little easier in terms of getting out of paying PMI for the entire duration of the loan. But there are some ways you can get out of paying for PMI in the first place — or at least reduce your payments. The magic numbers in most cases are 80% LTV and 20% down payment. If you can get one of these objectives, then your chances of paying for PMI coverage indefinitely will decrease.
If you’re ready to take the next step on your home buying journey and still have questions, reach out to the home buying specialists at Hero Home Programs. They work with local vendors to save you thousands of dollars on your home purchase and can even help you find lenders, insurance, inspectors, and more.