How to Avoid Paying Private Mortgage Insurance (PMI)

Private mortgage insurance (PMI) is an insurance policy that protects lenders against default and foreclosure. In general, if you need financing to buy a home with a down payment of less than 20%, your lender will most likely ask you to get PMI insurance before signing off on the deal. Although it is an additional expenditure, PMI permits purchasers who are unable or unwilling to make a sizable down payment to obtain financing at reasonable rates.

Understanding Private Mortgage Insurance

PMI is a financial precaution mandated by lenders when homebuyers make less than a 20% down payment on a standard mortgage. The goal of PMI is to safeguard the lender in the case of a borrower default, as a lower down payment increases the lender's risk.

While PMI allows borrowers to secure a mortgage with a lower initial down payment, it increases their monthly mortgage payment, which can have a considerable influence on their overall housing expenses. For this reason, many buyers try to avoid paying PMI because the additional cost, no matter how modest, might be devoted to principal payments or other investments.

How to Avoid PMI

Achieve loan-to-value of 80%.

One approach to avoid paying PMI is to make a down payment equivalent to at least one-fifth of the home's purchase price; in mortgage terms, the loan-to-value (LTV) ratio is 80%. If your new home costs $180,000, you'll need to put down at least $36,000 to avoid paying PMI. While that is the simplest way to eliminate PMI, such a large down payment may be prohibitively expensive.

Invest in Highly Appreciable Property

If the value of your property has increased to the point that your LTV falls below 80%, certain banks will allow you to cancel PMI. However, in this case, the bank is likely to require an expert appraisal to accompany the request, with the borrower bearing the expense. Furthermore, keep in mind that real estate valuations may not improve significantly in a short period of time; the primary way this may be accomplished is by making a sizable down payment.

Secure a piggyback mortgage.

A piggyback mortgage is another option available to qualified borrowers. In this circumstance, a second mortgage or home equity loan is obtained concurrently with the first mortgage. An "80-10-10" piggyback mortgage, for example, covers 80% of the purchase price with the first mortgage, 10% with the second loan, and the remaining 10% with your down payment. This reduces the loan-to-value (LTV) of the initial mortgage to less than 80%, eliminating the requirement for PMI. For example, if your new home costs $180,000, your first mortgage is $144,000, your second mortgage is $18,000, and your down payment is $18,000.

Get Lender-Paid Mortgage Insurance

A last alternative is lender-paid mortgage insurance (LMPI), in which the cost of PMI is built into the mortgage interest rate for the duration of the loan. As a result, you may end up paying more in interest over the course of the loan. Though this officially avoids PMI, you will still be paying for additional new expenditures, therefore this has the same effect as indirectly increasing your monthly payment obligation.

Enter Government-Backed Loan

Government-backed loans, such as Federal Housing Administration (FHA) or Veterans Affairs (VA) loans, frequently offer reduced down payment requirements and may not require PMI. However, these loans have their own qualifying requirements and may include additional fees. Similar to lender-paid mortgage insurance, avoiding PMI may result in increased indirect or soft costs.

Pay Lump-Sum PMI

Some lenders may allow you to pay for PMI upfront in one flat payment rather than monthly premiums. While it takes a greater initial payment, it can save you money over time compared to paying PMI monthly due to the time value of money. For instance, some lenders would prefer to have a discounted amount of capital upfront utilizing a discount rate.

Ending PMI Early

Once you've had your mortgage for a few years, you may be able to eliminate PMI by refinancing—that is, replacing your current loan with a new one—but you must consider the expense of refinancing against the costs of continuing to pay mortgage insurance charges. You may also be able to pay off your mortgage early if you have at least 20% equity (ownership) in your property. Once you've accumulated that level of equity, you can ask the lender to terminate your PMI.

PMI usually ends when you keep up with your mortgage payments. When the mortgage's LTV ratio falls to 78%—meaning your down payment plus the loan principal you've paid down equals 22% of the home's purchase price—the federal Homeowners Protection Act mandates the lender to immediately terminate the insurance.

The Bottom Line

Lenders require private mortgage insurance when a borrower makes less than 20% down on a typical home loan. Its objective is to safeguard the lender in case the borrower defaults on the loan, thereby lowering the lender's financial risk. To avoid paying PMI and lower overall mortgage expenses, borrowers can consider placing a 20% down payment, pursuing government-backed loans, or opting for lender-paid PMI.