What Is Private Mortgage Insurance (PMI)?
Private Mortgage Insurance (PMI) is an insurance requirement on mortgages when the buyer makes a down payment that is less than 20% home purchase price. The less the down payment, the greater the risk to a lender. The mortgage company wants protection against a default.
Based on research carried out by the National Association of Realtors, 61percent of the first-time home buyer’s down payment was six percent or even less. PMI does not cover the homebuyer. Instead, the hefty premium only protects the lender. Therefore, it’s crucial to avoid Private Mortgage Insurance if possible. If not, the best thing is to get rid of it soonest possible.
How to Avoid PMI
You can avoid paying PMI in various ways.
Make at least 20% down payment of the purchase cost.
When applying for the mortgage, you will encounter the loan-to-value ratio (LTV). This is a comparison of the home loan amount to the home value. You want the LTV ratio to be at most 80% to avoid PMI.
How to calculate the LTV ratio? Take the loan amount and the house value and compare the two. For instance, if the mortgage is $200,000 and the property costs $250,000, your LTV ratio is 80%. When this ratio is greater than 80%, PMI is needed.
Use a Piggyback Mortgage
This involves partially covering the down payment using a second mortgage which eliminates PMI. For instance, if you are eyeing a house worth $150,000, but you have only saved for 10% down payment, you may obtain an 80% mortgage rather than a 90 percent mortgage and then another mortgage to cover the 10% remainder. This type of arrangement is often termed as the 80/10/10 agreement.
Using our example, you will take an 80 percent loan of the total home value or $120,000. You will get another loan; the piggyback, worth $15,000, 10 percent the home value. This means you will have to put down $15,000, the final 10%. Although a piggyback mortgage helps you get rid of PMI, it has its drawbacks. Typically, a second mortgage comes with a higher interest rate.
Mortgage Programs without PMI
There are mortgage programs that don’t require Private Mortgage Insurance such as VA loans. The U.S. Department of Veteran Affairs guarantees VA home loans for veterans. VA loans are sourced from private lenders. These loans do not require mortgage insurance fees or a down payment, which helps the home buyer save money.
How to Pay for PMI
There are several ways to make Private Mortgage Insurance payment. Paying a monthly premium is the most common policy of payment. This payment is an additional fee on top of the monthly mortgage bill.
Secondly, you can make a bulk payment known as the single- premium mortgage insurance. If you pay upfront and then refinance or move, you might not qualify for a refund.
You can also combine both and pay a certain amount upfront and make monthly payments for the rest.
Alternatively, you could go for lender-paid mortgage insurance (LPMI). In this case, the lender makes your mortgage insurance payment in exchange for a higher interest rate. Eventually, home buyers who go for LPMI have a reduced mortgage payment compared to those who pay PMI monthly. However, you cannot cancel LPMI.
How Do you Get rid of the PMI on your Mortgage?
When you pay down your mortgage balance to 80% the original home value, you can request your lender for PMI cancellation. To succeed, ensure you are up to date with the monthly mortgage payments, have no other mortgages, a positive history of payment, and the request must be done in writing.
The mortgage servicer should eliminate PMI when the balance has dropped to 78 percent of the original home value. You also need to be up to date with your payments.
Final PMI termination is another option. Lenders must end PMI automatically one month after you hit the midpoint of your loan term even when the balance is more than 78%.
You can also refinance your loan to eliminate PMI. This gets rid of PMI if the mortgage is at most 80% of the current home value. You can use this approach if it’s possible to lower the loan interest from refinancing.