Key Takeaways  

  • PMI is insurance that protects the lender and is required on conventional loans where the down payment is less than 20% of the home price
  • There are some loans that don’t require PMI
  • There are ways to avoid PMI or have it removed

You’ve been dreaming of the day you’ll get the keys to your new home. You’ve been saving for that down payment, but houses are expensive, and you don’t yet have 20% for a conventional down payment.

Your mortgage options look good, but you’re wondering if there’s a way to get around paying private mortgage insurance (PMI). We have good news for you: there are many alternatives to PMI.

What is PMI?

Private mortgage insurance, or PMI, is insurance you’re usually required to pay when your down payment on a conventional loan is less than 20% of the home value. PMI protects the lender if you stop making payments. 

The average cost of PMI for a conventional home loan ranges from 0.5% to 1.5% of the loan amount on an annual basis. What you pay for PMI largely depends on your down payment and credit score.

PMI is usually added to your monthly mortgage payment. If it’s required, you’ll find it on your Loan Estimate and Closing Disclosure next to “Mortgage Insurance.”

Alternatively, PMI is sometimes paid at closing as a one-time up-front premium. Ask your lender how they structure PMI and what alternatives they offer.

Why would you buy discount points?

As you know, your personal financial situation determines your loan terms. If you have excellent credit, a reliable income, and not too much debt, you’re going to qualify for the best interest rate. Real life is a bit messier for most of us, though, and a lender may offer a rate that is higher than you prefer to pay. If other aspects of your home loan are within your plan and budget, but your interest rate isn’t as low as you’d like, that’s where discount points can be extremely helpful. 

Another way to think of it is that by buying a point, you are prepaying interest to obtain a lower monthly payment. Buying discount points to lower your interest rate can save you thousands of dollars over the life of the loan, provided you plan to live in the home long enough to recover what you paid up front for the lower interest rate.

Avoiding PMI

There are three main strategies for avoiding PMI when you put down less than 20% on your new home.

  1. Find a program that doesn’t require PMI
  2. Use lender-paid mortgage insurance (LPMI)
  3. “Piggy back” with a second mortgage
Find a program that doesn’t require PMI

Earlier, we mentioned that PMI is usually tied to conventional loans. A “conventional loan” is a mortgage that’s not insured by the federal government. These mortgages are often offered by private lenders. 
To avoid PMI, consider a loan program offered by the government, such as a VA loan, or look for conventional mortgage programs with no-PMI features.
  • VA loans: Home loans from the U.S. Department of Veterans Affairs (VA) help service members, veterans and their surviving spouses become homeowners. You don’t need a down payment, and there is no PMI.

Unless you qualify for an exemption, you’ll pay a one-time funding fee, but overall, the cost is usually lower than a similar conventional loan with PMI. Plus, VA loans usually come with low interest rates, making them a fantastic option for qualifying buyers.

  • Conventional loans: Some lenders offer conventional loans that do not require PMI, even if your down payment is under 20%. These loans often apply to specific buyers, like first-time homeowners, teachers, doctors, or farmers. 
 The requirements for every program are different, but they all offer incentives that bring the cost of homeownership down. Let your lender know — or ask — if you think you may qualify for one or more of them.

Use lender-paid mortgage insurance

Considering a conventional loan that doesn’t have any special program features that would waive PMI? You may still be able to avoid PMI by having the lender pay the mortgage insurance. This is called lender-paid mortgage insurance (LPMI). 
The trade-off with LPMI is a higher interest rate for the life of the loan. Having an excellent credit score and at least 3% down payment will help to lower the rate.
With PMI, you can request to have it removed once you have at least 20% equity in your home, and PMI automatically drops off once you have 22% equity, whether you request it or not.  
Whether it’s cheaper to pay PMI or a higher interest rate depends on several factors, including how long you plan to stay in the home or keep the same mortgage. It also depends on your particular tax situation (both mortgage interest and PMI may be tax-deductible, but under different conditions). You should seek the advice of an accountant to confirm what applies to your situation. 
It may sound complicated, but your loan officer can help you understand which option benefits you most.

Piggy-back with a second mortgage

Some lenders may allow you to make a down payment, and at the same time take out a second mortgage (usually a home equity line of credit, known as a HELOC), that covers the rest of the traditional 20% down payment so you don’t pay PMI. This is called a “piggyback mortgage.” 
Piggyback mortgages are usually structured this way:
80% first mortgage
10% second mortgage (HELOC)
10% down payment
You usually use the same lender for both mortgages, but you can always find another lender if yours doesn’t offer the piggyback option. Credit unions can be a great resource for this type of loan.
Keep in mind that second mortgages typically have higher interest rates than first mortgages. Determining the benefit of this strategy requires a comparison of how much extra interest you’ll pay on the second mortgage versus what you’d pay in PMI. A mortgage loan officer can help you determine if this is right for you. 

Removing PMI

Even if your loan has PMI, you might not have to pay it forever. PMI is removed in one of two ways: you can request to have it removed once you have enough equity in your home, or you can wait until PMI automatically drops off.

Once your loan’s principal balance drops to 80% of your home’s value (also referred to as your Loan-To-Value ratio), you can submit a request to your lender to remove PMI. However, you will need to prove that the value of your home has increased enough, which will generally mean you have to pay for a new appraisal. If the home doesn’t appraise for enough to eliminate the PMI, you’ll be out the cost of the appraisal, so you want to be confident before you make the request.

Most lenders also require you to keep mortgage insurance for at least 2 years, so even if your home has gone up significantly in value in the first couple of years, you may have to wait to request its removal.

Once your Loan-To-Value ratio reaches 78% of the original home value, the lender is required by law to remove PMI for most mortgages, whether you request it or not, assuming you’re all caught up on your mortgage payments.

Don’t get stuck with PMI forever

PMI makes it possible for you to afford a home sooner, sometimes years before you’d otherwise be able to save up 20% for a down payment. But that doesn’t mean you’re stuck with it — or that you even need it in all situations.

Reach out today to find out how you can avoid PMI and buy your home with the down payment you have. Or explore how refinancing could eliminate your PMI sooner.

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