Personal Finance

How To Avoid Paying Private Mortgage Insurance

By David Krug David Krug is the CEO & President of Bankovia. He's a lifelong expat who has lived in the Philippines, Mexico, Thailand, and Colombia. When he's not reading about cryptocurrencies, he's researching the latest personal finance software. 8 minute read

Your monthly mortgage payment likely includes private mortgage insurance if a line item labeled “PMI” appears. But why do we need it? What are the obligations and exemptions of those who must pay for it? The key question is how you can prevent it in the future.

Here is all the information you need about PMI to start saving between $50 and $250 every month.

Why Would You Need Private Mortgage Insurance?

There is always a chance of a borrower defaulting on their loan and stopping payments altogether. Therefore, financial institutions try to mitigate this danger. High default rates are inevitable in some businesses, such as payday lending; yet, lenders can make a profit on the small percentage of borrowers who repay their loans in full by charging exorbitant interest rates.

More rules have been put into place for the mortgage business. In addition to protecting themselves from potential losses in two ways, lenders can charge substantially lower rates of interest. The lender will first record a mortgage or other lien against the property; if the borrower defaults, the lender can foreclose and sell the home at auction to recoup any losses on the loan.

However, the foreclosure process is time-consuming and costly for lenders, and repossessed properties typically fetch lower prices than other listings. Lenders stand to lose money in this scenario if there is little to no equity in the home.

This brings up the second method by which mortgage lenders are safeguarded: mortgage insurance. Borrowers can mitigate the lender’s financial exposure to the possibility of a default by purchasing mortgage insurance.

When a mortgage borrower obtains private mortgage insurance, the lender receives a policy from a legitimate insurance provider. In the event of a loan failure and subsequent foreclosure and sale of the property, the lender may seek reimbursement from the mortgage insurance policy. The insured person receives a check from the insurance company to cover some or all of the loss.

What Your Down Payment Means

In some cases, borrowers can avoid paying mortgage insurance altogether. When purchasing a home, private mortgage insurance (PMI) is not required if the down payment is 20% or higher. Assuming, of course, that you go with a normal mortgage as opposed to an FHA or VA loan (which we’ll get to in a minute).

A mortgage loan allows you to borrow money up to a set proportion of the value of the property you are purchasing. The worth of a house is equal to its selling price. The value of your current house is determined by the lender’s appraisal when you refinance.

The lending industry refers to the amount you borrow as the loan-to-value ratio (LTV). If you borrow $150,000 to purchase a home that costs $200,000, your loan-to-value (LTV) ratio is 75%. Mortgage insurance premiums are required only for borrowers whose loan-to-value ratios (LTVs) are above 80%.

Mortgage Insurance for Conventional Loans vs. FHA, USDA, and VA Loans

Private mortgage insurance is a concept used exclusively in the context of conventional loans. Loans that meet the requirements of Fannie Mae or Freddie Mac are an example of this type.

When the loan-to-value ratio of a conventional loan drops below 80%, the borrower can petition to have the PMI removed. This can help buyers get into a home with a smaller down payment, and then, after a few years of mortgage payments, they can avoid paying the PMI.

Many government organizations have their own special financing schemes for first-time homebuyers with low credit scores and no or little down payment funds. The most frequent of them is the Federal Housing Administration’s loan program, which requires only a 3.5% down payment from the buyer.

Unfortunately, there is a catch to what sounds like an irresistible offer. In the case of a loan with a down payment of 10% or less, the MIP must be paid for the duration of the loan, regardless of the principal balance. There is a one-time MIP fee due at closing that buyers must pay as well; more on that in a minute.

The MIP is calculated the same way whether you obtain a USDA loan for a rural home. In addition to the origination cost, you’ll have to make monthly MIP payments for the duration of the loan.

VA loans provide an additional financing choice with attractive advantages for eligible military veterans. Almost no other loan programs match the low minimum down payment requirements of these loans.

They also handle mortgage insurance differently, with no required premium payments. VA funding fees, on the other hand, are paid in advance but can often be financed into a loan. It accomplishes the same goal of safeguarding the VA against financial losses due to defaults.

It’s worth noting that the VA provides several exemptions from the requirement to pay the VA funding fee, such as for disabled veterans and surviving spouses.

What Does PMI Cost?

Rates for standard home loans typically range from $40 to $70 per $100,000 borrowed. You can play around with Freddie Mac’s PMI calculator to get a better idea of the cost of PMI, which changes depending on your LTV and other risk variables.

The interest rate on your mortgage insurance will be different if you get an FHA loan. The upfront mortgage insurance cost is 1.75 percent of the loan amount and is due at closing. See FHA’s MIP tables for specifics on how much your monthly premium will be based on the term of your loan and your LTV.

Costs for MIP are reduced for USDA loans. The initial MIP on these loans is 1% of the loan amount, and the yearly MIP paid monthly is 0.35 % of the loan amount.

VA funding fees are assessed to borrowers of VA loans in varying amounts based on loan-to-value (LTV) and repeat use of VA loans. For more details, check out the financing fee charts and the complete list of exemptions for those who are eligible for VA benefits.

How to Reduce the Cost of Private Mortgage Insurance

According to the preceding section, mortgage insurance is optional. If you want to save money on your mortgage, give these strategies a try.

1. Steer clear of FHA loans

The Federal Housing Administration (FHA) mortgage is a great option for first-time buyers with low down payments and poor credit. This goes against the grain of common sense, but some lenders are willing to accept as little as 3.5% down from borrowers with credit scores as low as 580.

The FHA is able to make this system operate by having taxpayers subsidize these loans and by charging MIP for the duration of the loan.

Borrowers who want to avoid paying MIP for the duration of their loan should look into getting a conforming mortgage. Time spent paying down debt or saving for a larger down payment is two ways to boost creditworthiness.

2. Put 20% Down

As expected, avoiding private mortgage insurance (PMI) by making a down payment of at least 20% of the home’s purchase price is the obvious solution. Of course, this could mean delaying buying a property until you have saved up more money. Explore alternative strategies to increase your savings rate and get your money put away sooner.

3. Consider a Second Mortgage

Some banks and credit unions still provide an 80/10/10 piggyback mortgage scheme, however, it is much less typical now than it was even a decade ago.

This type of financing calls for a 10% down payment in addition to a 20% first mortgage loan and a 10% second mortgage or home equity line of credit loan. By getting a loan for only 80% of the value, you can avoid having to pay private mortgage insurance.

Ask around several lenders regarding piggyback loans if you can only afford a 10% down payment and are worried about entering the region of jumbo mortgage loans.

4. Reduce Your Loan Balance Rapidly

Borrowers who put down less than 20% typically pay private mortgage insurance premiums but try to reduce their loan-to-value ratio (LTV) as soon as possible to avoid paying the premiums.

The federal Homeowners Protection Act mandates that, so long as you remain current on your loan and make your payments on time, your lender must automatically cancel your PMI whenever your loan debt reaches 78% of the original purchase price or appraised value.

However, you can bypass the system’s delay in canceling your subscription. If you’ve paid down your mortgage to 80% or less of your home’s current value, you may qualify to have private mortgage insurance (PMI) dropped from your payment schedule.

To determine how much your home is worth, the lender will normally send out an appraiser; don’t expect them to simply accept your word for it or the valuation you found using Zillow. 

You can’t just ask a buddy who happens to be an appraiser to do you a favor, because the lender chooses and pays the appraiser.

5. Mortgage Refinancing

Take into account the monthly payment increase along with the closing costs before deciding to refinance your mortgage. It usually benefits the lender at the expense of the homeowner, so makes little sense for the homeowner to pursue it.

There are a number of ways in which refinancing will set you back financially. The first and most noticeable is the addition of perhaps thousands of dollars to the total closing price. Financial institutions will tell you, Don’t worry about it, we’ll just roll them into your loan. to brush this issue under the rug.

Debt repayment might be spread out over a longer period of time when you refinance. Lenders rely on the fact that most borrowers will subconsciously treat the remainder of a loan’s term as though it were far in the future when setting interest rates.

Once that’s done, your amortization schedule will begin again from the beginning. That implies your monthly payments will once again go primarily toward interest rather than reducing your principal sum.

Monthly mortgage payments are a prime target for lenders trying to sell you on a refinance. Instead, compare the overall life-of-loan cost of a refinances with the total life-of-loan cost of your current mortgage. What you find probably won’t be to your liking.

Refinancing could be beneficial if you have a high-interest rate on your present loan and a significantly lower interest rate is available with the new loan. However, it is important to do one’s own thorough math before giving in to a sales presentation.

Bottom Line

If you want to buy a house with a little down payment, private mortgage insurance is a necessary expense. That’s why a 20% down payment on a house is worth considering.

Learn the mortgage insurance requirements for both conventional loans and government-backed loans. Before signing on the dotted line, consider your options and make sure you fully grasp the PMI’s regulations.

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