How to avoid PMI when buying a home

In May 2020, U.S. home sales dropped to their lowest point in nearly 9½ years. Yet, the median price of a home rose to $317,900, up almost $15,000 from one month earlier. At that price, you would need a 20 percent down payment of $63,580 to get into a home and avoid paying private home insurance (PMI).

What is PMI and how much does it cost a month?

Private mortgage insurance, or PMI, protects lenders from the risk of default on a mortgage loan. It is offered by private insurance companies and is usually required if you can’t make a 20 percent down payment. PMI is also sometimes necessary when refinancing your current mortgage if the equity in your home is less than 20 percent of your home’s value.

As a rule, the cost and how long you pay PMI is based on the original loan amount, your credit score, and the percentage of your home’s value that would be due if you defaulted on your mortgage loan. “PMI ranges from 0.55 percent to 2.25 percent of the loan's original value annually,” according to the Government National Mortgage Association, or Ginnie Mae.

HOW DO I GET RID OF PMI ON MY MORTGAGE?

What are today’s mortgage rates?

Mortgage rates rise and fall daily. In July 2020, rates were substantially lower than they have been in many years. At the time of reporting, Freddie Mac announced an average 30-year fixed rate of 2.98 percent, the lowest rate reported in 50 years. It’s also the fifth time in the past three months that rates have broken a new record. A 15-year fixed-rate mortgage averaged 2.48 percent, and a 5-year adjustable-rate mortgage (ARM) averaged 3.06 percent, up slightly from the week before.

However, with uncertain times, new coronavirus cases reported over the past several weeks, and temporary layoffs at risk of becoming permanent job losses, rates may continue to drop, only to rise once the economy stabilizes.

MORTGAGE RATES ARE LOW - HERE'S WHY IT'S A GOOD TIME TO REFINANCE

Do all lenders require a PMI?

If your down payment is less than 20 percent, most lenders will require private mortgage insurance for a conventional mortgage. Other government-insured loan programs, such as the Federal Housing Administration, or FHA, require a mortgage insurance premium, or MIP, no matter the amount of your down payment. However, unlike private mortgage insurance, MIP is not private insurance and not offered by private-sector companies.

WHAT IS PMI AND HOW DOES IT WORK?

Is PMI worth it?

Although PMI can add thousands of dollars in extra costs to your mortgage loan, there may actually be times when private mortgage insurance is worth it. Today’s mortgage rates are the best they’ve ever been and may be the best they’ll ever get. For this reason, paying PMI to get you into a home may be a good idea rather than waiting to save up the 20 percent needed as a down payment and risk rates increasing.

But if money is a factor or you are recently unemployed, the drawbacks far outweigh any benefits to paying private mortgage insurance. Until the total equity in your home reaches 20 percent–which can take years–you will likely have to pay private mortgage insurance. PMI isn’t that easy to cancel, and it’s not tax-deductible.

Not to mention the cost. If your PMI is 1 percent of the entire loan amount that you pay annually, and your loan is $300,000, you’ll pay $3,000 a year or $250 per month in private mortgage insurance.

DO YOU NEED MORTGAGE INSURANCE?

How do I avoid paying a PMI?

• Make a 20 percent payment. The best way to avoid paying private mortgage insurance is to save up the 20 percent needed as a down payment.
• Get a loan with a higher interest rate. Lender-paid mortgage insurance, or LPMI, is much like PMI except that the lender charges you a higher interest rate in exchange for paying the insurance premium.
• Obtain a government-insured loan. If you qualify for a VA loan, you can benefit from no down payment and no PMI, as the government guarantees the loan itself. The government also guarantees Federal Housing Association (FHA) loans. These loans, however, require both upfront and annual mortgage insurance no matter how much you put down.
• Get a “piggyback loan.” A piggyback loan, sometimes called a combo loan or an 80-10-10 loan, is a second loan along with a conventional mortgage loan that provides the funds you need to get into a home without the full 20 percent down payment. The first mortgage covers 80% of your home’s purchase price. The other loan is piggybacked on top of the first mortgage and takes care of the balance of the purchase price, eliminating the need for PMI.

HOW TO GET PRE-APPROVED FOR A MORTGAGE

Maybe you’re not certain how much mortgage you can afford. Use a mortgage calculator to estimate your monthly payment and all other costs associated with your mortgage. Keep in mind that when PMI is required, you’ll want to factor it into your monthly payment, which will include principal and interest, along with homeowner's insurance and real estate taxes (if they aren’t paid separately).