Speaking in basic terms, lenders will only lend 80 percent of the appraised value, and the buyer puts up the other 20 percent as the down payment.
So what happens if someone has a good credit score, but less than 20 percent to put down? This is where PMI comes in. PMI (Private Mortgage Insurance) is an insurance policy for the mortgage lender. For a fee, a third party insures the mortgage for the difference of the actual down payment and the 20 percent required by the lender.
If it weren’t for PMI, many home-buyers wouldn’t have been approved for the mortgage used to buy their home. Most borrowers who pay less than 20 percent down on a loan will be required to obtain PMI.
Yes, it makes house payments higher and yes, it sticks around far too long. Worse of all, although it’s called “insurance,” it does nothing to protect the homeowner. Its sole beneficiary is the loan holder.
There are however, some loans which will waive the PMI requirement when the borrower makes a lower down payment. Such as those for physicians and other medical professionals.
The most popular mortgage program among first-time buyers, who are low on cash, is the FHA-backed loan.
It, too, has a mortgage insurance requirement, known as the “mortgage insurance premium,” or MIP for short.
Consider yourself fortunate if you obtained an FHA-insured mortgage before June 2013. You will be able to ditch the MIP payment once your equity in the home reaches 22 percent of the loan amount (for a 15-year loan). Whether or not, and when, more recent borrowers can dump the MIP depends on your down payment and the length of the loan.
For loan terms of 20, 25 and 30 years, with a 10 percent down payment, you’re stuck with MIP for the life of the loan. For the same terms, with a more-than 10 percent down payment, you can cancel MIP after 11 years.
Fifteen-year or less term? With a less-than 10 percent down payment you will be, again, required to pay the MIP for the life of the loan. Put down more than 10 percent and you can cancel it in 11 years.
PMI and Conventional Loans
Conventional loans, are a bit more amenable to cancelling PMI. Reach 20 percent equity in the home and call your lender to terminate the PMI.
The Homeowner’s Protection Act of 1998, mandates that the loan holder must terminate PMI, without a call from you, when the loan reaches a 78 percent loan-to-value ratio (LTV). Meaning that you have 22 percent equity.
The beauty of this law is that it’s not based on your actual payments made, but rather on the date the loan should reach the magic 78 percent LTV. Which you’ll find on the initial amortization schedule.
You can also dump PMI on a Conventional Loan at the amortization schedule’s midpoint – regardless of your equity.
The USDA and VA loans and PMI
One would assume that a loan with no down payment required, would have one hefty PMI premium. But the USDA loan has none. However, you will be required to pay an annual fee – but it’s typically less than the average PMI premium.
And, since the VA loans are guaranteed by the U.S. Department of Veterans Affairs, the no-down payment VA loan doesn’t require the purchase of private mortgage insurance either.
The PMI “Buy-Out”
Private Mortgage Insurance provider MGIC, claims that a borrower who puts 5 percent down on a $250,000 home will pay $150 a month for PMI.
Instead, if you’d rather have smaller monthly mortgage payment and use that money elsewhere – consider a “buy-out” of the PMI. “You’ll pay a slightly higher interest rate – typically an 1/8 to 3/4 percentage point” (according to Billy Slobin, Senior Loan Officer at Mortgage One, Inc. in Farmington, MI – http://www.mtgonemichigan.com/teamslobin/). “Of course, each case is unique and evaluated individually” – adds Billy.
Lenders typically only offer this option to credit-worthy borrowers. In other words, good credit risks. If you have a low credit score and little to put down on a home, this tactic isn’t for you.
Refinance your way out of PMI
If you’ve built-up equity refinancing makes sense – especially when mortgage rates are low. Not only will you dump the PMI, but you’ll reduce your monthly interest payments!
According to Holden Lewis at BankRate.com, some loans require a two-year wait to refinance after obtaining a mortgage.
Consider a Piggy-Back Mortgage Loan
Also known as 80/10/10 loans, Piggy-Back mortgages have three “legs.” The first leg, is a 10 percent down payment. Then, the lender will provide you with two loans – one for 80 percent of the home’s purchase price (second leg) and a second mortgage for 10 percent (third leg).
“The piggyback loan is still debt and money you need to repay. And it comes with its own monthly payments – which can be quite high. For that reason, home-buyers should be cautious about taking on a piggyback loan”, warns Kali Hawlk at Unicom.com.
Other ways to get off the PMI wheel
Have the home appraised – Some lenders will accept this appraisal in lieu of using the original value when determining your current loan-to-value ratio. Appraisals can be pricey, so speak with your lender first.
Increase the value of your home – Some remodeling projects raise a home’s value better than others. Before heading down this path, speak with your lender to find out if your LTV will be recalculated using a new value after the remodeling project.
Pay down your loan – Pay extra every month to bring down your loan balance.
There is a lot more to know about PMI and how to avoid it or get rid of it. We aren’t lenders or mortgage professionals, but we are happy to put you in touch with one.