Jeffrey Wade
Private mortgage insurance (PMI) is an added cost homebuyers must pay if they purchase a home with a down payment of less than 20%. This insurance protects the lender in case the borrower defaults on the loan. Typically, a lender will require you to pay for PMI if your down payment is less than 20% on a conventional mortgage. Fortunately, there are ways to make a down payment of less than 20% without paying PMI premiums on your monthly mortgage payment. For example, VA loans don’t require PMI, so if you qualify you could save a bundle.
| Characteristics | Values |
|---|---|
| Down payment | 20% or more |
| Lender-paid mortgage insurance | Pay a higher interest rate |
| Piggyback mortgage | Take out a second mortgage loan |
| First-time home buyer loans | Special loans without PMI |
| VA loans | For current and veteran service members and eligible spouses |
| USDA loans | Zero-down mortgages for lower- and moderate-income buyers in designated rural and suburban areas |
| FHA loans | Remove PMI by paying the loan back in full or refinancing the loan |
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What You'll Learn
Make a down payment of 20% or more
Making a down payment of 20% or more on a conventional home loan is one of the most straightforward ways to avoid paying Private Mortgage Insurance (PMI). This type of insurance is typically required by lenders when homebuyers make a down payment of less than 20% of the home's value.
Lenders view a lower down payment as a higher-risk loan, and PMI protects them in case the borrower defaults. PMI is an added cost for the homebuyer, increasing the overall cost of the loan. It is usually rolled into the monthly mortgage payment, but it can also be paid upfront at closing.
If you can make a down payment of 20% or more, you can avoid the extra expense of PMI. This option may be feasible if you opt for a less expensive home or use gift money to reach the 20% threshold. Lenders usually allow gift money for down payments, provided it is a genuine gift from immediate family members, affirmed by a "gift letter".
However, it's important to note that even with a 20% down payment, some lenders may require you to maintain a PMI contract for a designated period. Be sure to read the fine print of your PMI contract to understand if this applies to your situation.
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Take out a VA loan
Taking out a VA loan is a great option for current and former military service members and their spouses to become homeowners. VA loans are backed by the Department of Veterans Affairs and are available from private companies, including banks, credit unions, and mortgage companies.
One of the most significant advantages of VA loans is that they do not require private mortgage insurance (PMI). This is a considerable benefit as PMI can add a significant amount to your monthly mortgage payments. Instead of PMI, VA loans have a one-time funding fee of 2.15% for first-time homebuyers and 3.3% for subsequent loans. This fee is not considered a mortgage insurance premium but a lender's flat fee, and it is rolled into the cost of the loan. It's important to note that disabled veterans may qualify for a funding fee waiver.
VA loans also offer the convenience of speed and flexibility. You can use a VA loan to buy a home immediately, without having to save for a down payment, as they require $0 down. Additionally, VA loans can be used multiple times, so if you decide to sell and upgrade to a bigger home, you can reuse your VA loan benefit.
To check your eligibility for a VA loan, you will need to obtain your DD Form 214. With this document, a VA-approved lender can request your VA Certificate of Eligibility, or you can request it directly from the VA's eBenefits website. It's worth noting that VA loans have slightly lower interest rates than conventional loans, making them even more attractive for those who are eligible.
In summary, if you are a current or former military service member or eligible spouse, taking out a VA loan is an excellent way to avoid PMI while also benefiting from other features like lower interest rates and the convenience of speed and flexibility.
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Explore lender-paid mortgage insurance
Lender-paid mortgage insurance (LPMI) is an option for borrowers who cannot afford a 20% down payment on a home and want to avoid paying private mortgage insurance (PMI). With LPMI, the lender covers the cost of mortgage insurance, but recoups this money by charging a higher interest rate on the loan. This results in a lower monthly payment compared to PMI, but the loan will likely cost more over time. LPMI cannot be cancelled and will remain in effect for the life of the loan unless you refinance.
LPMI is a good option for those who want to keep their monthly payments affordable. It is also beneficial if you have excellent credit, as you may pay less in interest compared to PMI. Additionally, LPMI can be combined with other loan products, such as VA loans, to further reduce costs.
However, there are some drawbacks to consider. Firstly, LPMI may cost more over the life of the loan due to the higher interest rate. Secondly, LPMI cannot be cancelled, unlike PMI, which can be cancelled once the borrower reaches a certain level of equity in their home. Therefore, it is important to consider how long you plan to stay in the home and your long-term financial goals before opting for LPMI.
To make an informed decision, it is recommended to compare offers from several lenders and consider various loan options, such as special first-time homebuyer loans without PMI or piggyback mortgages, which involve taking out two loans to effectively make a 20% down payment and avoid PMI altogether.
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Take out two mortgages, or a piggyback second mortgage
Taking out two mortgages, or a piggyback second mortgage, is a strategy that can help you avoid paying PMI. This approach involves using two mortgages to ensure that neither mortgage is for more than 80% of the home's value. Here's how it works:
Let's say you want to purchase a house priced at $200,000, but you only have enough funds for a 10% down payment. With a piggyback mortgage strategy, you would take out one loan for 80% of the total value of the property, which is $160,000. Then, you would take out a second loan, known as the piggyback loan, for the remaining 10% of the value, which is $20,000 in this case. This strategy allows you to effectively have a 20% down payment without paying PMI.
The second mortgage, or piggyback loan, is often obtained from the same bank or lender as the first mortgage. However, if your lender does not offer this option, you may need to find a separate lender for the second mortgage. Credit unions or local banks are great sources for this type of loan. It's important to ensure that the second lender is aware of your home purchase and financing timeline.
It's worth noting that the second mortgage typically carries a higher interest rate than the first mortgage. Therefore, it's essential to carefully consider the financial implications and compare the costs of PMI with the interest on the piggyback loan. Additionally, remember that a piggyback loan adds an extra financial burden, so be sure to assess whether it results in overall savings or if paying for PMI makes more sense.
While the piggyback loan strategy can help you avoid PMI, it's not the only option. Other ways to avoid PMI include making a down payment of more than 20%government-backed loan, or opting for lender-paid PMI, which may result in a higher mortgage rate over the loan's life. Ultimately, it's important to weigh the pros and cons of each option and make a decision that aligns with your financial situation and goals.
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Research various mortgage products and their requirements
When it comes to mortgages, there are a variety of options available, each with its own set of requirements. It is important to carefully consider the type of interest rate that makes the most sense for your specific situation. The two main types of interest rates are fixed-rate and adjustable-rate mortgages. With a fixed-rate mortgage, your interest rate and monthly principal and interest payments remain the same throughout the term of the loan. This option is ideal if you value certainty about your long-term loan costs. On the other hand, adjustable-rate mortgages (ARMs) typically have an introductory period with a fixed interest rate, followed by a variable rate that fluctuates based on market changes. This means your monthly payments could potentially double.
The length of the mortgage term is another important consideration. The most common mortgage terms are 15-year and 30-year fixed-rate mortgages, but terms can range from as short as five years to 40 years or longer. Generally, shorter loan terms result in higher monthly payments but can save you money overall, as you pay less interest over time.
There are also various government-backed programs that make homeownership more accessible to specific populations. These include Federal Housing Administration (FHA) loans, which typically require mortgage insurance for low down payments, and United States Department of Agriculture (USDA) loans, which are zero-down mortgages for lower- and moderate-income buyers in designated rural and suburban areas. Additionally, the U.S. Department of Veterans Affairs (VA) offers loans with no down payment or mortgage insurance requirements for current and veteran service members and eligible spouses.
When choosing a mortgage product, it is essential to compare rates and consider your long-term objectives. By understanding the requirements and costs associated with each option, you can make an informed decision that best suits your financial situation and goals.
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Frequently asked questions
PMI stands for private mortgage insurance, which is a type of insurance commonly required by lenders when home buyers make a down payment of less than 20% of the home’s value.
PMI adds an extra monthly fee, increasing the overall cost of the loan.
One way to avoid PMI is to increase your down payment to at least 20% of the home’s purchase price. Alternatively, you could consider lender-paid mortgage insurance, explore special first-time home buyer loans without PMI, or take out a piggyback mortgage.
Lender-Paid Mortgage Insurance (LPMI) is when the mortgage lender covers your mortgage insurance so you don’t have to pay out of pocket. However, you will pay a higher interest rate in return.
A piggyback mortgage is a second mortgage used to fulfill the down payment requirements so that the homebuyer does not have to pay PMI. The buyer will hold two mortgages instead of one, and they may have different interest rates.
