There are many fees associated with buying a house, from inspections to appraisals to insurance. Most buyers don’t want to spend more than they need to, so it’s a good practice to do some research to find out just what you’re paying for and avoid unnecessary costs.
If you’re in the market to buy a home, a cost you’ve likely run across that might have left you feeling confused is private mortgage insurance, or PMI. Chances are, if you’re putting down less than 20%, you’ll be required to take on PMI.
In this post, we will explain what PMI is and why it may be required, how you can avoid it, and look at the total cost structure of PMI versus a higher down payment.
When and Why is PMI Required?
Private mortgage insurance (PMI) is an insurance policy meant to protect lenders from a buyer defaulting on their loan. In most cases, if you’re getting a mortgage and putting down less than 20%, you’ll be required to pay for PMI.
This helps ensure that the lender can recover the cost of the loan if you don’t make your payments and the home goes into foreclosure. But if you can avoid this cost by putting down 20% or more, why do people get it at all? That’s because putting down a lower percentage enables you to get a loan much quicker than you might otherwise.
Ways to Avoid Paying for PMI
Make A 20% Down Payment
The most simple and obvious solution to avoid paying for PMI is to put down 20% when taking out a conventional loan. That higher down payment will lower your monthly mortgage cost and usually garners a lower interest rate. You’ll also start your loan with at least 20% equity and potentially be able to shorten the term of your loan since you’re financing less.
Accept A Higher Interest Rate
You might get the option to finance at a higher-than-market interest rate, with the provision that the lender will take on the cost of the private mortgage insurance. This is called lender-paid mortgage insurance. While it might sound good, you’ll want to look at a side-by-side comparison of the loan with the best rate with PMI and the lender-paid program you’re offered. Be sure to compare them thoroughly, including the total cost of each loan.
Use an 80-10-10 Loan
An 80-10-10, or “piggyback loan,” enables you to cover 90% of your home price between 2 loans: one that covers 80% of the house and another that covers a 10% down payment, paired with 10% down in cash from you. This structure allows you to bypass the need for PMI.
Loans backed by the Department of Veterans Affairs, commonly known as VA Loans, don’t need any down payment and also don’t require PMI. These are available to current members of the military and veterans.
Finance through a State Bond Program
There are many state bond programs designed to address the typical barriers that prevent first-time and move-up buyers from being able to achieve their goals. Learn how to find a program for you, and you might also be able to avoid or reduce your mortgage insurance costs.
Should You Make A Higher Down Payment to Avoid PMI?
There’s no magic formula to help you answer this question, but we can provide some guidance on what you should consider. Rather than looking strictly at the dollar amount you’ll pay for PMI versus your down payment, it’s better to consider your monthly cash flow.
You can use these questions to help guide your decision-making:
- If I make a larger down payment, am I leaving enough of a cushion in my savings to cover unforeseen homeownership expenses?
- Does the addition of PMI to my monthly mortgage cost put me in a range where I would feel stretched thin on paying my bills?
Stop Paying for PMI After Reaching 20% Equity
After you’ve paid 20% of the cost of your home, known as a 20% equity stake, you may be able to get rid of PMI through refinancing your mortgage. There are usually closing costs associated with refinancing, so it’s best to compare those against your PMI cost to ensure it’s a cost-savings. Some loans also allow you to request cancellation of PMI once you’ve reached the 20% equity stake. It’s best to reach out to your lender or loan servicer for more information about cancelling PMI, as they can tell you what options are available based on the terms of your loan.
Another important milestone to keep in mind is that the Federal Homeowners Protection Act (HPA) requires lenders to cancel PMI once the mortgage’s LTV ratio drops to 78%. This happens when your down payment plus the loan principal you’ve already paid off equals 22% of your purchase price.
While PMI can seem intimidating, our goal is to empower you with a basic understanding and prepare you to make the best financial decisions when it comes to buying your home.
You don’t have to weigh making a higher down payment or factoring in PMI on your own. Our team will work with you to gain an understanding of your mortgage needs and provide you with options that work for you. Reach out today to get started on your mortgage journey.
The included content is intended for informational purposes only and should not be relied upon as professional advice. Additional terms and conditions apply. Not all applicants will qualify. Consult with a finance professional for tax advice or a mortgage professional to address your mortgage questions or concerns. This is an advertisement. Prepared 3/25/2021.