What Is Private Mortgage Insurance (PMI), and How to Avoid It?
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What is private mortgage insurance (PMI) and how to avoid it?
Some people postpone buying a home because they think they need a 20% down payment.
Yes, this is a traditional down payment amount. But surprisingly, many people purchase homes with far less cash.
The good news is that several mortgage programs only require 3% to 5% down when buying a house. This allows many to buy sooner rather than later, so they can start building equity. Unfortunately, private mortgage insurance, or PMI, is often required when buying a home with less than 20% down.
What exactly is private mortgage insurance? And more importantly, how can you avoid PMI?
1. What is private mortgage insurance?
Private mortgage insurance is a type of insurance that’s usually required when someone purchases a home with less than a 20% down payment.
Mortgage lenders are in the business of originating home loans, but there are risks associated with each loan. Typically, the more personal cash a borrower has at stake, the lower the risk of default. Since a lower down payment increases this risk, lenders charge PMI to protect themselves in the event of borrower default.
But while this insurance protects lenders, borrowers are responsible for these payments – which are included with their home loan payment.
2. How does private mortgage insurance work?
It’s also important to understand how PMI works. If you get a conventional home loan, you’ll pay private mortgage insurance until your property has between 20% to 22% equity.
Conventional mortgage lenders will waive this insurance once a property has 22% equity. But at your request, they’ll remove it once you have 20% equity.
Understand, too, that other home loan programs have their version of mortgage insurance. This includes FHA home loans and USDA home loans. In both cases, mortgage insurance is usually for life. The only exception is when you get an FHA home loan with at least 10% down. In this case, you’ll only pay mortgage insurance for the first 11 years.
To remove PMI with a USDA and FHA home loan, you can refinance the mortgage once you have 20% equity.
If purchasing a property with a VA home loan, you’re not required to pay mortgage insurance.
3. How to avoid private mortgage insurance?
The first way to avoid private mortgage insurance is to put down at least 20% when buying a home. This can be challenging with limited resources. It’s usually easier to buy with 20% when selling a property and using proceeds from the sale.
Some mortgage programs also allow borrowers to use gift funds for their down payment or closing costs. Depending on the mortgage, you might have to contribute some of your own funds. Between your funds and a gift from a parent or grandparent, you might have enough for a 20% down payment—which eliminates the need for private mortgage insurance.
Another way to avoid private mortgage insurance is to ask your lender about a portfolio loan.
When a lender creates a loan, they’ll often sell it on the secondary market. This provides lenders with a steady stream of income to create new loans. But mortgage companies and banks don’t sell every loan they create. They keep some loans as part of their own portfolio.
The lending requirements for these loans aren’t as strict. So if you don’t have a 20% down payment, the lender may waive private mortgage insurance—if you agree to a higher mortgage rate.
Or, you can get a first mortgage for 80% of the sale price, a second mortgage for 10% of the sale price, and then give the mortgage company a 10% down payment.
Final Word on PMI
Private mortgage insurance is an added expense, yet it helps you buy a home sooner and with less money out-of-pocket. Even if you pay private mortgage insurance at the beginning of your mortgage term, you can always get rid of it later—whether the lender removes it or you refinance the mortgage.