Home Buying Without Paying Private Mortgage Insurance (PMI)
What is PMI or Private Mortgage Insurance and is it Necessary?
If you are looking to buy your first home or buying a home with less than 20% down payment, private mortgage insurance (PMI) may be a requirement of your loan. PMI is a type of insurance that insures the lender in case the buyer defaults on the loan. The lender, or bank, requires PMI when the buyer has a down payment of less than 20% of the asking price of the home. Private mortgage insurance has good and bad points, and there are ways to avoid paying it without putting down the required 20%, not all loans require PMI.
Private Mortgage Insurance Has Its Good Points
The good point about PMI is that it allows you to buy a house without having to save up the required 20%. Buying a home and investing in property is a good way to build equity instead of spending money on rent. PMI allows potential homeowners who do not have enough savings to make a 20% downpayment the option of still getting the home, with less money down.
How Does Private Mortgage Insurance or PMI work?
The lender may usually offer several options to pay for PMI.
- They may add it to the mortgage payments
- They may accept for you to make a lump sum payment at the time of closing to cover the private mortgage insurance premium
- They may require a lump sum partial payment at signing, mortgage fees and/or add the remainder to your mortgage installments.
Private mortgage insurance is arranged for you by the lender, if something goes wrong, the insurance pays the lender and not you. Paying for private mortgage insurance has costs, and this needs to be considered when budgeting for your new home if you take a loan that requires PMI.
How Does PMI Compare to Home Insurance?
When you purchase a home you are required to purchase traditional homeowner's insurance. Private mortgage insurance does not include homeowner's insurance coverage, but it does give the bank insurance just in case you do not fulfill your obligations by not paying your mortgage payments. You will need home insurance to cover the reconstruction cost of your home and the personal contents in your home plus PMI to protect the lender if you default on your mortgage.
The use of PMI has been a great tool to get more Americans into homes with lower down payments, but there are some downfalls.
The Downfalls of PMI
The problem with private mortgage insurance is that it raises your monthly payment and, unlike the interest on a traditional mortgage, PMI is not tax-deductible. You can eventually cancel private mortgage insurance if you can prove that you owe 80% or less of your home's value. Getting your mortgage balance down to 80% of the home's value can take many years.
Options to Avoid Paying Private Mortgage Insurance (PMI)
When borrowing money for your new home purchase there may be ways to avoid paying the private mortgage insurance. For example, according to the Consumer Financial Protection Bureau, you may have other options.
Find out if you can get a loan from the same lender at a higher interest rate without PMI. Even though the idea of a higher interest rate may seem like it will be more expensive, once you do the math on the cost difference between a no PMI loan, vs a high-interest rate loan, you may end up saving money overall.
Look into alternate loans, such as Federal Housing Administration Loans (FHA loans). FHA loans may allow you to put a down payment as low as 3-5% and are insured by the Federal Housing Administration. Also, rather than requiring PMI, these government-backed loans do require mortgage insurance protection (MIP). MIP is broken into a one-time fee and a monthly fee based on the term of the FHA loan. Depending on your credit score, the FHA loan may or may not be a better option for you to consider.
Can You Remove Private Mortgage Insurance?
Yes, there are different circumstances where you can cancel your PMI. For example, the federal Homeowners Protection Act (HPA) provides circumstances where you can request to remove the PMI from your home. If you start to build equity in your home, then it is a good idea to review the situation. Consider switching mortgages if you qualify for a different kind of loan after a few years.
In some circumstances, the PMI may automatically be canceled once you reach a certain level of equity, but each lender may be different.
It is a good idea to ask your lender about what will happen when you reach close to 80% and under what circumstance PMI may be canceled automatically (if ever) or if you have to go through a certain procedure to remove your PMI insurance.
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