How Can I Avoid Paying Private Mortgage Insurance—PMI?

PMI (private mortgage insurance) is a type of insurance that protects lenders from default and foreclosure. If you need financing to buy a home with a down payment of less than 20% of the purchase price, your lender will almost certainly ask you to purchase PMI insurance before signing off on the transaction. Despite the fact that it is more expensive, PMI allows purchasers who are unable to make a substantial down payment (or who prefer not to) to obtain financing at reasonable rates.

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How to Avoid Paying PMI

Making a down payment of at least one-fifth of the home's purchase price; the mortgage's loan-to-value (LTV) ratio is 80 percent in mortgage parlance, is one strategy to avoid paying PMI. For example, if your new home costs $180,000, you'll need to put down at least $36,000 to avoid PMI. While this is the simplest approach to eliminate PMI, such a large down payment may not be possible.

Furthermore, if the value of your house has increased to the point where your LTV is less than 80%, some banks will allow you to request PMI cancellation. However, in this case, the bank is likely to require an expert appraisal to accompany the request, with the borrower bearing the expense.

A piggyback mortgage is another alternative for suitable borrowers. A second mortgage or home equity loan is taken out at the same time as the first mortgage in this case. For example, in a "80-10-10" piggyback mortgage, the first loan covers 80% of the purchase price, the second loan covers 10%, and your down payment covers the remaining 10%. This reduces the first mortgage's loan-to-value (LTV) to under 80%, removing the need for PMI. Your first mortgage would be $144,000, your second mortgage would be $18,000, and your down payment would be $18,000 if your new home costs $180,000.

Lender-paid mortgage insurance (LMPI) is a final alternative, in which the cost of PMI is included in the mortgage interest rate for the duration of the loan. As a result, you may end up paying more interest during the loan's term.

TAKEAWAYS IMPORTANT

• If you need to finance more than 80% of the purchase price of a home, you'll have to pay private mortgage insurance (PMI).
• You can avoid PMI by taking out a first and second mortgage on your property at the same time, so that no single loan accounts for more than 80% of the total cost.
• Lender-paid mortgage insurance (LMPI) is an option, however it usually raises your mortgage's interest rate.
• Once you have at least a 20% equity ownership in the home, you can request that your PMI payments be cancelled.

Early PMI Termination

After a few years, you may be able to avoid PMI by refinancing—that is, replacing your current loan with a new one—though you'll have to consider the expense of refinancing against the cost of continuing to pay mortgage insurance charges. You may also be able to get rid of it sooner if you pay off your mortgage principle early enough to have at least 20% equity (ownership) in your house. Once you've reached that level of equity, you can ask the lender to cancel your PMI.

In most circumstances, PMI will be eliminated if you keep up with your mortgage payments. The federal Homeowners Protection Act mandates the lender to terminate the insurance whenever the loan's LTV ratio lowers to 78 percent — meaning your down payment plus the loan principal you've paid off equals 22 percent of the home's purchase price.