Paul Sanchez
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 type of insurance protects the lender in case the borrower defaults on the loan. Fortunately, there are several ways to avoid paying PMI, including making a 20% down payment, using a VA or USDA loan, paying a higher interest rate, or getting a piggyback loan, among other options.
| Characteristics | Values |
|---|---|
| Down payment | 20% or more |
| Loan type | VA, USDA, FHA, or lender-paid mortgage insurance |
| Credit score | High |
| Number of mortgages | Two (in the case of a piggyback loan) |
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What You'll Learn
Make a 20% down payment
Making a 20% down payment on a conventional home loan is one of the most effective ways to avoid paying private mortgage insurance (PMI). PMI is a type of insurance that lenders typically require when homebuyers make a down payment of less than 20% of the home's value. It protects the lender in case the borrower defaults on the loan. By making a 20% down payment, you can eliminate this additional cost, which can add a significant amount to your overall loan.
For example, let's say you're purchasing a $300,000 home. A 20% down payment would amount to $60,000. By making this larger down payment, you can avoid the extra monthly fee of PMI, which could save you a significant amount of money over the life of your mortgage.
It's important to note that simply reaching the 20% equity threshold might not be enough to automatically cancel PMI. In some cases, lenders may require you to take additional steps, such as writing a letter requesting the cancellation of PMI or even getting a formal appraisal of your home. This process can take several months, during which you may still need to pay PMI. Therefore, it's essential to carefully review the terms of your loan and understand the requirements for cancelling PMI.
While making a 20% down payment can help you avoid PMI, it may not be the only factor to consider. Your mortgage credit score, debt-to-income (DTI) ratio, and the interest rate on your loan can also impact your overall costs. Additionally, there are alternative loan options available, such as lender-paid mortgage insurance (LPMI) or special first-time homebuyer loans that don't require PMI, even with a lower down payment.
Before committing to a 20% down payment solely to avoid PMI, it's advisable to consult with a mortgage advisor. They can help you explore alternative down payment programs, understand the short- and long-term financial implications, and make an informed decision that aligns with your specific circumstances and homeownership goals.
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Get a VA loan
If you are a current or former member of the military, or an eligible spouse, you may qualify for a VA loan. VA loans are backed by the Department of Veterans Affairs and do not require a down payment or private mortgage insurance. This is a significant benefit for VA borrowers, as private mortgage insurance can add a significant amount to the overall cost of a loan.
However, it's important to note that VA loans do have a one-time funding fee, which helps to lower the cost of the loan for US taxpayers. This fee can be paid upfront or rolled into the loan amount. The VA funding fee is typically 2.15% of the loan amount but ranges between 0.5% and 3.30%. Not every veteran is required to pay it. You won't have to pay a VA funding fee if any of the following apply to you:
- You are receiving VA compensation for a service-connected disability.
- You are eligible to receive VA compensation for a service-connected disability but are receiving retirement or active-duty pay instead.
- You are receiving Dependency and Indemnity Compensation (DIC) as the surviving spouse of a veteran.
VA loans also offer competitive interest rates and the ability to borrow up to the Fannie Mae/Freddie Mac conforming loan limit in most areas, with higher limits in some high-cost counties.
If you are eligible for a VA loan, be sure to compare the costs of a VA loan with a conventional mortgage to choose the best deal.
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Get a USDA loan
USDA loans, backed by the U.S. Department of Agriculture, are an incredibly affordable option for lower- and moderate-income buyers in designated rural and suburban areas. These loans are geared towards buyers who want to live outside urban areas, whether in a quiet suburb, a small town, or the countryside.
USDA loans are unique in that they don't require a down payment, making them a great option for buyers who cannot put down a large sum of money upfront. They also offer competitive interest rates and flexible credit score requirements.
While USDA loans don't require traditional private mortgage insurance (PMI), they do have their own version of mortgage insurance in the form of a guarantee fee. This fee, known as the USDA annual fee, serves the same purpose as PMI and helps protect lenders against potential losses. The fee is calculated as 0.35% of the loan's balance and is paid as part of your monthly mortgage payment for the life of the loan.
In addition to the annual fee, USDA loans also have a one-time upfront guarantee fee of 1% of the loan amount. This upfront fee can be included in the loan amount or paid separately using various funding sources.
To qualify for a USDA loan, you must meet certain requirements. Firstly, the property must be located in a USDA-eligible rural or suburban area, which you can determine using the USDA's property eligibility map. Secondly, your household income must fall within the USDA's income limits for your area, typically not exceeding 115% of the median household income. Other requirements include occupying the property as your primary residence and meeting the preferred credit score of 640 or higher.
Overall, USDA loans offer a great opportunity for buyers seeking affordable options in rural and suburban areas, providing benefits such as zero down payment, competitive rates, and flexible credit requirements, along with their unique form of mortgage insurance.
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Pay a higher interest rate
Paying a higher interest rate is one way to avoid paying private mortgage insurance (PMI). This is because the higher interest rate covers the insurance cost to the lender, and interest is tax-deductible, unlike PMI premiums. However, it is important to note that you will have to pay the higher interest rate for the life of your mortgage, while PMI will be terminated once the loan balance reaches 78% to 80% of the original property value.
The decision to pay a higher interest rate instead of PMI depends on various factors, including your tax bracket, the life of the mortgage, and the PMI premium. If you have a high tax bracket, the higher interest rate option becomes more attractive because of the tax deductibility of interest. Additionally, if you plan to stay in your house for a short time, the higher interest rate option may be more advantageous since tax savings are typically highest in the early years of the mortgage.
The PMI premium also plays a role in the decision. A higher PMI premium makes the higher interest rate option more appealing. You can calculate the potential savings by using tools like the “Pay For Mortgage Insurance or Pay a Higher Interest Rate” calculator, which takes into account factors such as your tax bracket, expected property appreciation, and PMI premium.
It is worth noting that certain loan programs, such as Freddie Mac Home Possible or Fannie Mae HomeReady mortgages, allow homebuyers to take out a loan with a low down payment and avoid PMI, reducing overall costs. Additionally, if you are a qualified veteran or servicemember, you may be eligible for a VA home loan, which does not require mortgage insurance or a down payment.
In summary, paying a higher interest rate can be a strategy to avoid PMI, but it is important to carefully consider the various factors and alternatives mentioned above before making a decision. Consulting with an accountant or a licensed mortgage agent can provide personalized advice and ensure you make an informed choice.
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Get a piggyback loan
A piggyback loan is a loan you take out alongside a primary mortgage to avoid paying private mortgage insurance (PMI). It is a unique second loan where the buyer needs only 10% down in cash. The buyer then takes out a second mortgage loan, which provides another 10% of the home's purchase price. This means they effectively have a 20% down payment and do not have to pay mortgage insurance.
The most common piggyback loan arrangement is an 80/10/10 loan, where the primary mortgage covers 80% of the sales price, the piggyback loan finances 10%, and the down payment covers the remaining 10%. However, there are other configurations, such as an 80/20 loan, where the primary mortgage covers 80% and the remaining 20% is covered by the second mortgage, eliminating the need for a down payment or private insurance.
Piggyback loans can be beneficial for buyers who want to avoid a large down payment or want to buy a higher-priced home. They can also help borrowers build home equity faster and may come with tax benefits. However, they do come with risks and costs. The second mortgage typically has a higher interest rate than the first, and the rate can be variable, increasing over time. Qualifying for a piggyback loan can be more challenging, and there may be additional closing costs.
Before pursuing a piggyback loan, it is essential to understand how this type of financing works and whether it fits your financial situation. Make sure to compare the costs and benefits carefully and run the numbers to ensure you are not paying more in the long term with a higher rate than you would with PMI.
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Frequently asked questions
Make a 20% down payment on a conventional home loan.
A piggyback loan, also called an 80-10-10 loan, is a second loan where the buyer needs only 10% down in cash. The buyer then takes out a second mortgage loan, which provides another 10% of the home’s purchase price. So they effectively have a 20% down payment and do not have to pay mortgage insurance.
With LPMI, your lender pays the mortgage insurance upfront in exchange for charging a higher interest rate on the mortgage.
VA loans, backed by the Department of Veterans Affairs, are for current and veteran service members and eligible spouses. They don't require a down payment or mortgage insurance, although there is a one-time funding fee.
USDA loans, backed by the U.S. Department of Agriculture, are zero-down mortgages for lower- and moderate-income buyers in designated rural and suburban areas. Although USDA loans don't require mortgage insurance, they come with upfront and annual fees.
