How to Avoid PMI Mortgage Insurance

How to Avoid PMI Mortgage Insurance

There are a number of ways for borrowers to avoid or reduce the amount of mortgage insurance typically required when obtaining a mortgage. First let’s look at what mortgage insurance is, what it does and does not do.

Mortgage Insurance covers the mortgage lender against loss caused by a mortgagor's default. It may cover all or part of the loss and it may or may not relieve any liability on the borrowers part if default on the mortgage occurs.

Private mortgage insurance was developed to help borrowers purchase a home without putting 20% down as was required by banks and lenders many years ago. I like to think of it as a "hired co-borrower"

Different types of loans refer to it in different ways, and some loans have different requirements for the amount of coverage needed, but it essentially serves the same purpose. It helps protect the lender. Not all loans require mortgage insurance and the premium varies due to different criteria.

Conventional Mortgages
When the loan to value for an owner–occupied residence is more than 80% (or the borrower is putting less than 20% down) then Private Mortgage Insurance (or PMI), is typically required. The premium may be paid on an annual, monthly or single premium plan.

(The most popular method of payment is the monthly method). The premiums are based on the amount and terms of the loan and may vary according to the loan-to-value, type of loan, term of loan and the amount of coverage required by the lender. The less the borrower puts down the higher the premium. PMI may be waived when the loan reaches 80% or less of the value of the property.

VA Mortgages
A VA loan is guaranteed by the Veterans Administration (VA) and the lender is required to collect an up-front one-time fee at closing called the "Funding Fee". This amount is between .50% and 3.00% of the loan amount depending upon the status of the Veteran and if the Veteran has used his VA Benefits previously to purchase a home.

There is no monthly premium and there is no refund of the Funding Fee when the loan–to-value is reduced below 80% or if the loan is paid off early.

FHA Mortgages
Regardless of the amount of the down payment, FHA requires a one time upfront fee of 2.25% of the loan amount which, may be financed in with the loan. In addition to the upfront fee there is a yearly fee of .50% of the unpaid balance of the loan which is divided into 12 equal payments and paid monthly in the house payment.

If the loan is paid in full within the first 7 years there may be a prorated refund of the upfront premium paid. The monthly mortgage insurance premium may not be waived regardless of the loan to value.

Now the good news. There are ways to reduce or even avoid paying mortgage insurance. Here are just a few examples.

Put 20% down on a Conventional loan. The down payment may be a gift from a relative or it may be borrowed against the borrowers own assets, such as loan against the borrowers 401k, auto, etc.

Have your lender or mortgage broker set up two loans. The "first" mortgage of 80% and a "second" for 10% or 15%.

Apply for an 80% mortgage and have the seller carry back a "second" mortgage.

Ask your lender about special mortgage programs that do not require mortgage insurance. These programs (LPMI) typically have a higher interest rate but still the overall payment is less than with mortgage insurance.

Have the lender set up Lender Paid Mortgage Insurance. In this case you pay a higher interest rate and the lender pays your mortgage insurance for you. Since the mortgage insurance is "built-in" to the interest rate it may be tax deductible. The draw back to this is that since there is no "mortgage insurance" it can’t be dropped when the property value reaches 80% or less.

Anytime mortgage insurance is required on a home loan discuss with your lender or mortgage broker what other options and loan programs may be available to reduce or even avoid mortgage insurance.

The easiest way to avoid PMI is to make a cash down payment of 20 percent or more. Potential sources of additional cash include:

• Borrowing against your 401(k) retirement plan
• Taking a margin loan against your stock
• Asking relatives for a gift
• Refinancing your car and taking cash out
• Selling your car, jewelry, etc.

In the event you are unable to make a 20 percent cash down payment, consider these options:

Piggy Back Loan: 

A piggy back loan usually allows you to avoid PMI even though you are making a down payment of less than 20 percent. The most common piggy back loan combinations are:

• 80-10-10:  Eighty percent first loan, 10 percent second (piggy back) loan, 10 percent cash down payment.
• 80-15-5:  Eighty percent first loan, 15 percent second loan, 5 percent cash down payment.
• 80-20:  Eighty percent first loan, 20 percent second loan, no cash down payment.

Even though the second loan rate may be higher than the first loan rate, you usually come out ahead since you don't have to pay PMI. Also, the interest on the second mortgage will likely be fully tax-deductible.