In this post:
- What Is PMI?
- How To Avoid PMI: 7 Ways
- How To Avoid PMI When Buying a Home
When you get a loan for a new home, you need the loan amount to be something you can afford so that you can continue making payments on time to pay down your loan balance and build equity in the home. However, mortgage insurance can add to the cost of your mortgage. Learning how to avoid PMI, or private mortgage insurance, is excellent knowledge for a home buyer to have to reduce the costs of their mortgage loan.
How to Avoid PMI: 7 Ways
- Pay a Down Payment of At Least 20%
- Get the Right Type of Mortgage Instead of a Conventional Loan
- Settle for a Higher Interest Rate
- Get a Piggyback Loan
- Consider Other Ways to Make a PMI Payment
- Check If Assistance Programs are Available
- Refinance Your Current Mortgage
First things first: What is mortgage insurance?
Private mortgage insurance, also known as PMI, is insurance you have placed on your mortgage that offers protection to your mortgage lender. PMI amounts generally range between 0.5% and 2% of the loan amount, split into a monthly payment added to a monthly mortgage payment.
Usually, PMI is reserved for home loans on which the borrower doesn’t pay the recommended 20% down payment, as these situations put the mortgage lender at a higher risk if the borrower doesn’t pay their monthly mortgage payment. Homebuyers who are buying a house with bad credit may also be required to pay PMI with their mortgage payment each month, as this home loan would also be riskier for the lender.
However, monthly PMI doesn’t need to stay with a homebuyer throughout the life of their loan. Instead, it drops from a borrower’s monthly bill when the mortgage’s balance drops to 80% of the home’s value.
How To Avoid PMI: 7 Ways
Whether you have bad credit or can’t afford a significant down payment, you still can own a home, thanks to the many types of home loans that exist today. Still, depending on your financial situation, your lender may require you to pay a monthly mortgage insurance premium in addition to your mortgage loan premium.
It’s important to know how to avoid PMI as you search for the right loan and lender for the home you want to buy.
Private mortgage insurance is typically a requirement of lenders for borrowers who need to finance at least 80% of their home. Therefore, a 20% down payment is often the minimum lenders look for to reduce their risk and provide a mortgage.
If you can afford to put a down payment of at least 20% on your new home, you likely can avoid the PMI cost altogether. As a bonus, you may qualify for better mortgage rates by doing so, which will reduce the amount you pay over the life of your loan, too.
Unfortunately, a 20% down payment is unaffordable for many homeowners. If the purchase price of your home is $200,000, you’ll need at least $40,000 down.
Can’t make it work? Try reaching out to friends and family who might be willing to offer you a loan. Or, some sellers participate in what’s known as seller financing, which can provide you with a loan for your down payment that you’ll pay back over time.
Don’t settle for the first mortgage or lender you come across. Some mortgage loans are better than others for people who want to learn how to avoid PMI.
Here are a few to consider if you qualify for them:
- VA Loan: VA loans do not require a down payment or PMI. Only eligible service members and veterans can apply for a VA loan.
- USDA Loan: USDA loans are for low-income homebuyers in eligible rural areas. They don’t require a down payment or PMI.
- FHA Loan: Administered through the Federal Housing Administration (FHA), an FHA loan doesn’t require PMI but requires another form of mortgage insurance known as mortgage insurance premiums (MIP). However, some are paid upfront and rolled into the loan rather than paid as an additional monthly payment, which could make MIP more affordable for some borrowers.
While it’s natural to want to lower your mortgage interest rate when buying a home, there may be situations in which you need to settle for higher mortgage rates to be eligible to borrow what you need for your home affordably.
Some lenders will accept negotiations for a higher interest rate instead of putting down a 20% down payment on your home and ending up with a PMI premium each month. Your interest rate may increase by as much as 1%, requiring you to pay more over the life of your loan. However, you’ll avoid higher monthly payments with additional PMI. Instead, you can tuck away extra money as additional principal payments to pay down your mortgage faster and decrease the interest you pay long-term.
A piggyback loan is essentially two mortgages. You can use one mortgage to finance a home with a 10% down payment. Then, you can secure a second mortgage to provide another 10% down payment, giving you the full 20% down payment needed to avoid PMI payments.
However, be aware that the second mortgage is another loan that uses your home as collateral, so it’s important not to default on your loan and treat it with the same care as you would your mortgage payment.
If PMI is unavoidable for your situation, check if your lender will allow you to pay the insurance using a method that works best for you. Aside from the typical PMI paid as a monthly premium, there are two additional types of PMI payments your mortgage lender may offer:
- Split-Premium PMI: With this method, a home buyer pays a lump sum of the PMI amount at closing, while the rest gets distributed as monthly payments. Doing this allows the home buyer to pay less each month for PMI.
- Single-Premium PMI: A home buyer using a single-premium PMI will pay the full PMI amount at closing to avoid having to pay it in monthly installments with their mortgage.
Your state or locality may offer down payment assistance programs to help you afford your new home while making the required down payment to avoid private mortgage insurance getting tacked onto your loan.
For example, Arizona offers qualified homebuyers help with a down payment through a second mortgage. The homeowner must remain in the home for three years to get the second mortgage forgiven.
Georgia also has an assistance program for up to $10,000 for eligible homeowners who work with the military, as teachers, or as public service workers. They may also qualify if someone in the household lives with a disability.
Check with your state or local housing authority to learn more about these programs.
When you refinance your mortgage, you can tap into your home equity and secure a mortgage with a lower interest rate to reduce your monthly payments. In addition to those benefits, refinancing your mortgage could help you drop your private mortgage insurance altogether.
The important thing to remember if you want to go this route is that you’ll need to refinance when you have enough home equity built into your home to forego the 20% needed to avoid PMI. That 20% equity acts as security for your lender, allowing you to get a mortgage without mortgage insurance.
Be aware that refinancing your mortgage is just like getting an initial mortgage for your home, so you’ll need to go through the same process, like getting an appraisal, underwriting, and closing on your loan. Be sure to refinance through mortgage programs and lenders that work for your current situation to get the best deal.
We’ve covered several tips for how to avoid PMI to help you reduce your monthly mortgage premium and focus on getting your home paid off. However, PMI isn’t the only way to ensure that your mortgage remains affordable. It’s also important to budget and spend wisely to avoid credit card debt or a drop in your credit score. These can both affect your ability to refinance your mortgage if you want to lock in a better mortgage rate in the future.
Check your free credit report annually to stay on top of your credit score and the factors affecting it. Several of the best credit cards also track your score each month for free.
If you’re currently in the home-buying process, consider starting a savings fund to use for a down payment. Making a 20% down payment on a conventional loan allows you to avoid PMI while also lowering your monthly mortgage payment, which is a beneficial step toward your future financial health.