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.
PMI may not be something you can avoid if you don't have enough money to put down on the house, which you need at least 20% to put down.
You can have a second loan that can take care of the PMI, but sometimes there isn't much of a cost difference.
If you can't avoid private mortgage insurance, there is one thing you can do to get rid of the PMI earlier. One of the things you can do is monitor your home value. Maybe you did a small home improvement where you added a bathroom or bedroom. As of late, home prices have been increasing which means your home value could be worth more than when you purchased it. Interest rates are still at all time lows, so you could refinance your house. When you refinance, your house will be revalued at the new market rates which could put your mortgages to home value above the 20% mark.
For example, lets say you bought a house for $350,000 in 2014 and your house was valued at $350,000. You put $30,000 down so you are still far away from getting rid of PMI because your mortgage is $320,000. However, a year or two later, the housing market has improved and your house is now worth more than $400,000. Interest rates haven't changed much so looking at refinancing to get rid of PMI may be worth looking at. When you go to refinance, they will assess your house at the new market value of $400,000, and your mortgage is still around $320,000 or less, which makes your equity now 20%. You have now removed the PMI from your mortgages. Before you do this, make sure when you refinance, your payment is less than what you originally were paying and make sure to talk to a mortgage broker to make sure it is worth looking at.
Vincent Oldre, CFP®
PMI is required on a home purchase where the down payment is less than 20%. So, PMI can be avoided by increasing the down payment on a home to 20%. Also, the lender is required to remove PMI once the loan's value decreases to more than 78% of the original loan value. While it may take a few years, you can keep up with your amortization schedule and notify the lender when the loan payoff reaches the 78% point.
There are a couple of options to avoid the PMI on your mortgage. If you put 20% as a down payment, then usually the PMI is not a factor. If you put less than the 20% down, PMI will be in effect until your equity reaches 20% of the original loan value. There are also some mortgages that will not require PMI, but you could be paying a higher interest rate.
Kim Howard, CFP