Home buyers unable to make a 20% down payment when buying their dream home can expect to pay private mortgage insurance (PMI) each month, but that doesn’t mean it has to live as long as the mortgage.
“The PMI is kind of a fact of life,” says Guy Cecala, publisher of Inside Mortgage Finance. “I wouldn’t struggle to try and avoid it…just make sure to monitor it.”
The premium is included in the mortgage bill and is calculated based on the size of the down payment, the type and size of the loan and the borrower’s credit score.
Before the 2007 housing crash, lenient lending practices made it easier to avoid PMI, but subsequent regulation has led to stricter standards that make the insurance harder to avoid.
Lenders are much more risk averse and want the insurance to protect themselves in the event the borrower can’t pay back the loan. There are some programs for first-time borrowers that reduce the down payment requirement, but those are the exceptions. Even with a Federal Housing Authority (FHA) loan, borrowers without a 20% down payment are required to pay insurance each month. With a FHA loan, the insurance requirement doesn’t go away once there is 20% equity in the home.
Home prices jumped double digits last year, and the average price is now hovering around $200,000, putting a 20% payment at $40,000.
For those that can’t afford to put 20% down and don’t want to pay PMI, Malcolm Hollensteiner, director of retail lending at TD Bank, suggests looking into a piggyback loan. With these loans, the borrower puts down 10%, takes out two loans with the first loan being at or below 80% of the value. The second loan covers the remaining 10%.
“Typically with the second mortgage there are two options: either a fixed or a variable rate loan, or a home equity line of credit for the second mortgage,” he says.
In the second scenario, borrowers may initially get an interest rate on the second loan that is lower than the first, but if rates increase, this move might not make financial sense.
“In some cases, the payment on the piggy back option might be lower, but in other cases, one mortgage and the PMI might be cheaper, so it’s important for buyers to discuss options with their lender to see what makes the most sense for them,” he says.
According to Cecala, there are housing agencies in some states that provide mortgages without PMI so it’s important to shop around. “Some of the programs have income limits but they are fairly generous income limits. It’s worth checking on, particularly for first-time home buyers who don’t have a lot for the down payment.”
Making a one-time upfront purchase of mortgage insurance on a conventional loan or one not backed by the government, can avoid monthly PMI payments, says Tony Auffant, director of sales at Academy Mortgage Corp.
“The upfront mortgage insurance is a lump sum that can be either paid at closing, paid by the seller or even financed into the home loan,” says Auffant. In the perfect situation, she says, the buyer would get the seller to take care of that lump sum, effectively removing any PMI the home buyer ever has to pay.
For homeowners already in a mortgage with a PMI, the easiest way to get it off the payments is to increase the equity in the home and/or see the property increase in value. According to mortgage experts, lenders are required by law to terminate the mortgage insurance when the loan balance is scheduled to reach 78% of the original value. The borrower also has to make at least 24 consecutive on-time monthly payments in a row, says Hollensteiner.
Keep in mind that the home has to be reappraised on homeowners’ dime if they are citing a rise in the property value for getting rid of the PMI. If the property value hasn’t gone up and the homeowner makes a big payment that brings the equity up, that’s also grounds for a lender to waive the PMI.
No matter their method of getting rid of PMI, Cecala stresses homeowners have to be their own advocate when it comes to PMI.
“Mortgage insurers are required to monitor the amount of equity and are supposed to eliminate it. But it’s one of those things you need to check on.”