A:

Private mortgage insurance (PMI) is an insurance policy that protects lenders from the risk of default and foreclosure, and allows buyers who cannot make a significant down payment (or those who choose to not to) to obtain mortgage financing at affordable rates. If you purchase a home and put down less than 20%, your lender will probably minimize its risk by requiring you to buy insurance from a PMI company prior to signing off on the loan.

One way to avoid paying PMI is to make a down payment that is equal to at least 20% of the purchase price of the home. If your new home costs $180,000, for example, you would need to put down at least $36,000 to avoid paying PMI. While that's the simplest way to avoid PMI, a down payment that size may not be feasible.

Another option for qualified borrowers is a piggyback mortgage. In this situation, a second mortgage or home equity loan is taken out at the same time as the first mortgage. With an "80-10-10" piggyback mortgage, for example, 80% of the purchase price is covered by the first mortgage, 10% is covered by the second loan, and the final 10% is covered by your down payment. This lowers the loan-to-value (LTV) of the first mortgage to under 80%, eliminating the need for PMI. For example, if your new home costs $180,000, your first mortgage would be $144,000, the second mortgage would be $18,000, and your down payment would be $18,000.

A final option is lender-paid mortgage insurance (LMPI) where the cost of the PMI is included in the mortgage interest rate for the life of the loan. Therefore, you may end up paying more in interest over the life of the loan.

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