How to Avoid PMI on a Mortgage With Less Than 20% Down | Mortgages

Private mortgage insurance, or PMI, has long been considered an expensive but necessary evil for homebuyers – especially first-timers without large down payments. There are several ways to get a mortgage without PMI, however, and one of those tactics might be right for you.

PMI protects the lender if you fail to repay your home loan. For instance, if you put 5% down on your home and then default on the loan, your lender will probably foreclose and sell the property. But foreclosure sale proceeds may not cover the loan balance if your down payment is small, so the insurer steps in and covers the shortfall.

The purpose of PMI is to protect the lender – not you.

PMI premiums increase your monthly mortgage payment, and that reduces what you can afford to spend for a home. Money that you could otherwise use to pay down your mortgage faster, use for other debt or add to your savings goes into the pockets of mortgage insurers instead.

How much does PMI cost? Potentially, a lot. It depends on your down payment percentage, type of loan and credit rating. The chart below shows what one national insurer charges for monthly premiums in the first year based on a $400,000 loan amount.

Every year, the payment is adjusted based on the remaining loan balance. Once the loan balance drops below 80% of the home’s original value, you can request PMI cancellation.

PMI can help you get into a home years before you’d be able to save a large down payment, so it’s not always a bad thing. But there may be less expensive ways to get what you need without paying for PMI.

Here are some of the most effective:

“Mortgage professionals should review all possible options with their clients so they can make an informed decision that best suits their financial needs,” says Rhonda Porter, a mortgage advisor in Seattle and author of The Mortgage Porter website.

The piggyback loan is a combination of two products: an 80% first mortgage and a “purchase money” second mortgage to increase your down payment to 80%. These loan combinations are named for the way they’re structured – for instance, an 80/10/10 piggyback means you put down 10%, get a 10% second mortgage and an 80% first mortgage. With an 80/15/5 piggyback, you get a 15% second mortgage and put down 5%.

“Two mortgages means the homeowner will have two mortgage payments due each month. This is a good option if the homeowner is going to have funds become available to pay down or pay off the second mortgage, which typically has a higher interest rate and sometimes a higher payment than opting for private mortgage insurance,” says Porter.

Lender-paid PMI is an arrangement in which the mortgage lender covers the cost of PMI for you. In this case, the lender pays a single premium to cover your mortgage insurance for the duration of your loan. Often, a single premium is much less expensive than monthly premiums (more on this below). So the lender may be able to cover the premium, charge you a slightly higher interest rate and still save you some money. And if you deduct home mortgage interest, the extra interest is tax-deductible, while mortgage insurance is not.

There is a downside with this arrangement: Your lender covers your mortgage insurance cost by increasing your interest rate, and that applies for as long as you have your mortgage. Even if you pay down your mortgage to less than 80% of the purchase price, you won’t be able to cancel lender-paid mortgage insurance and lower your payment.

Most people who pay for PMI don’t even realize that they don’t have to choose a monthly premium. There are single-premium options, which charge an up-front amount and no monthly payments, and split-premium options, which combine a smaller up-front amount and a smaller monthly premium.

This can be helpful if monthly PMI is preventing you from qualifying for your mortgage. You can pay the up-front sum yourself or, even better, get your seller to cover it.

“That way, the seller foots the bill to buy out your PMI, leaving you with a lower monthly house payment,” says Tim Lucas, lead analyst at MortgageResearch.com. Depending on the PMI premium, this strategy could save you a lot more than a reduction in your sales price, while for a seller who agrees to either the reduction or paying the PMI premium, it makes little difference.
Here are the single premium costs on a $400,000 loan from one national PMI provider.

Down payment assistance is a way to increase your down payment provided by community or faith-based organizations, government entities, and employers. Many programs are designed to help those with low-to-moderate income, first-time buyers or people with disabilities, while others are created to encourage buyers in redevelopment areas. You can find programs by looking for your state’s resources from the Department of Housing and Urban Development at hud.gov/states.

Assistance can be a low- to no-interest loan, a tax credit or a grant. In many cases, the loan requires no payments and is repaid when you sell the home. In other cases, the loan is forgivable after a certain number of years.

Qualifying may be easier than you think. In Oregon, for instance, buyers earning up to 100% of the area median income can qualify for down payment assistance of up to 20% of the purchase price or $60,000, whichever is less. Homebuyers must participate in First Time Homebuyer Education and meet with a certified housing counselor to discuss budgeting and housing goals prior to receiving the assistance funds and closing of the purchase transaction.

The Department of Veterans Affairs administers an important benefit for active service members, veterans and their households – the VA home loan. This loan requires no down payment or mortgage insurance. Those who are eligible have earned this valuable benefit and should always consider it when buying a home.

Then there are portfolio lenders that design their own programs and keep them on their own books. Many portfolio lenders offer mortgages without PMI. These lenders choose instead to self-insure and assume the default risk themselves. Expect to pay a higher mortgage rate, but your payment might be lower than a mortgage with PMI. The advantages and disadvantages are the same as for a mortgage with lender-paid PMI.

Finally, you may be able to finesse a seller-financed purchase or a lease option. Seller financing can mean the seller lends you money for a down payment as part of a piggyback combination. Or your seller could choose to finance the entire purchase for at least the first few years.

With a lease option, you rent the property with the option to complete the purchase within an agreed-on number of years. Both of these tactics give you time to improve your equity position and possibly your credit rating to help you reduce or eliminate required PMI.

Do your due diligence, get a home appraisal and hire a real estate attorney when structuring such a deal, because mistakes can be extremely costly.

Avoiding PMI isn’t always the right choice if the cost is higher than paying it. If you have a high credit score and, say, 15% down, your PMI would not be significant, and it would likely go away fairly quickly. In that case, choosing a loan with lender-paid PMI and a higher rate for the entire term might be costly. Always run the numbers before deciding.