What is PMI and How Can I Avoid Paying It?
If you’re getting ready to buy a home, then you’ve likely heard of private mortgage insurance (PMI). You might also have a basic idea of what it is, but do you understand why lenders charge PMI or how it’s derived? Below are important details about PMI, as well as some options for paying less PMI or, in certain cases, avoiding it entirely.
What is PMI?
PMI is a type of insurance paid to mitigate a lender’s potential loss if you default on the home loan. In other words, if you stop paying your mortgage, the lender will be able to recover some of their losses from the insurance company.
Why do I have to pay PMI?
Private mortgage insurance is required when you put less than 20 percent down when purchasing a home, or have less than 77 percent equity when refinancing your home. Basically, the lender wants a safeguard in the event you stop paying your mortgage (a.k.a. defaulting on the loan) so they can re-sell the property and recoup their investment.
PMI payment choices
There are many PMI choices available, and each will vary based on your individual financial situation:
Borrower paid mortgage insurance, monthly premium: This type of mortgage insurance is rolled into the monthly mortgage payment. This is the most common type of private mortgage insurance.
Borrower paid mortgage insurance, single premium: This option allows you to eliminate the monthly mortgage insurance payment by paying the full cost at closing or including it in the total cost of the loan amount.
Lender paid mortgage insurance: This allows for a one-time, upfront fee to be paid by the lender which eliminates the monthly PMI obligation. The lender typically covers the one-time upfront fee by slightly increasing the interest rate over the duration of the loan.
Split edge mortgage insurance: This option reduces your monthly PMI obligation by paying a percentage of the loan amount up to 1.25 percent. The greater the portion paid, the lower the monthly payment.
How do I avoid paying PMI?
Home equity lines of credit (HELOC) and home equity loans are one way to avoid paying PMI. It works like this: if you put down 10 percent, the first loan will be no more than 80 percent loan-to-value and the remaining 10 percent will be a HELOC or home equity loan.
Here are some basics on second mortgages. To be clear, both options require monthly payments:
HELOC: This is a line of credit with an adjustable rate. This type of loan is very similar to a credit card because as the principal balance is paid it becomes available for use. Additionally, you may have the option to pay interest only for several years.
Home equity loan: This is a true second mortgage with a fixed rate and fixed limit. You pay both principal and interest; however, there is no access to available equity as with a HELOC.
Other PMI facts:
- The amount of required PMI coverage is dependent on credit worthiness and the amount of your down payment. Basically, the lower your credit scores and down payment, the more monthly PMI you will pay. The difference is significant, so be sure to manage your credit health and save for a significant down payment.
- When using PMI, be sure your lender shops among PMI companies. (Yes, lenders can shop for these rates.) Ask the lender to verify the best available rate and not simply provide the first quote they are given.
- Second mortgages typically require a minimum credit score of 700.
- The interest you pay for your second mortgage is tax deductible; PMI is not tax deductible.
There are many PMI options available to you, so talk with your mortgage professional about all available programs, products and research tools. Remember, higher credit scores will yield more flexible options.
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