How to Avoid PMI When Buying a Home

Private Mortgage Insurance (PMI) is a type of insurance that protects your lender in the event you stop making payments on your mortgage. It’s not designed to protect you, the homeowner.

Lenders typically require PMI on conventional loans when your down payment is less than 20% of the home’s purchase price. While PMI can make homeownership more accessible by allowing you to buy a home with a smaller upfront investment, it’s important to remember that it adds to your monthly mortgage costs. Whether you’re buying a home in a competitive market like Denver or the bustling city of Dallas, there are other strategic options to explore to help you avoid paying private mortgage insurance.

How to avoid PMI when buying a home?

1. Make a 20% down payment or more

This is the most straightforward way to avoid PMI. If you can put down 20% or more of the home’s purchase price, lenders typically won’t require PMI because you have more equity in the home from the start, which reduces their risk. However, for many individuals, and especially first-time homebuyers, saving up such a substantial amount can be a significant challenge. 

Tips for saving a larger down payment:

• Budgeting and automatic savings: Create a strict budget and set up automatic transfers from your checking to a dedicated savings account for your down payment.
• Cut expenses: Look for areas to reduce spending, such as dining out less, canceling unused subscriptions, or reducing discretionary purchases.
• Utilize tax refunds: Instead of splurging, put your tax refunds directly into your down payment fund.
• Consider gifts: If family or friends are willing and able to help, a gift can boost your down payment. Be aware that lenders will require a gift letter to verify that the funds are indeed a gift and not a loan.
• Down payment assistance programs: Research state and local programs, especially for first-time homebuyers or those within certain income brackets. These can offer grants or low-interest loans.
• 401(k) loans or withdrawals: While generally not recommended as a first option due to potential penalties and impact on retirement savings, some plans allow borrowing or withdrawing for a home purchase. Consult a financial advisor for this.

2. “Piggyback” second mortgage (80/10/10 loan)

This strategy involves taking out two loans simultaneously:

• A first mortgage for 80% of the home’s value.
• A second mortgage (often a Home Equity Line of Credit or HELOC) for a portion of the remaining amount, typically 10%.
• You then make a 10% cash down payment.

This structure is known as an 80/10/10 loan (80% first mortgage, 10% second mortgage, 10% down payment). Since your first mortgage has an 80% loan-to-value (LTV) ratio, you avoid PMI on that primary loan.

Pros of a piggyback loan:

• Avoids PMI.
• Allows you to buy with less than 20% down.
• The second mortgage (HELOC) can sometimes be paid off faster, freeing up funds.

Cons of a piggyback loan:

• You’ll have two monthly mortgage payments.
• The interest rate on the second mortgage is often higher than the first mortgage and can be adjustable (variable).
• You’ll likely incur closing costs for both loans.
• Qualifying for two loans can be more complex and may require a higher credit score.

3. Lender-Paid Mortgage Insurance (LPMI)

With LPMI, the lender pays for the mortgage insurance premium instead of you paying it directly. In exchange, the lender typically charges you a slightly higher interest rate on your mortgage.

Pros of LPMI:

• No separate monthly PMI payment.
• Potentially lower monthly out-of-pocket payment compared to borrower-paid PMI.

Cons of LPMI:

• The higher interest rate lasts for the life of the loan (unless you refinance), even after you’ve built significant equity. With traditional PMI, you can usually get it removed once you reach 20-22% equity.
• Over the long term, LPMI can end up costing you more than traditional PMI.

4. VA loans (for eligible veterans and service members)

If you are an eligible veteran, active-duty service member, or surviving spouse, a VA loan is an excellent option. VA loans are backed by the U.S. Department of Veterans Affairs and offer significant benefits:

• No down payment required in many cases.
• No mortgage insurance (PMI) whatsoever.
• Often come with competitive interest rates.

5. USDA loans (for eligible rural homebuyers)

The U.S. Department of Agriculture (USDA) offers loans for low- and moderate-income homebuyers in eligible rural areas. These loans also typically do not require a down payment and have lower mortgage insurance costs compared to conventional or FHA loans.

Other considerations:

• FHA loans: While FHA loans are popular for low down payments (as little as 3.5%), they always require mortgage insurance premiums (MIP), which consist of both an upfront premium and an annual premium. For most FHA loans, this MIP stays for the life of the loan, unlike conventional PMI, which can be removed. If avoiding mortgage insurance is a primary goal, FHA loans are generally not the solution.

Before making a decision, it’s crucial to compare the long-term costs of each option with a qualified mortgage lender to see which one best fits your financial situation and homeownership goals.

How to remove Private Mortgage Insurance (PMI)

Many homeowners pay Private Mortgage Insurance (PMI) as part of their monthly mortgage payment, but did you know you might be able to get it removed? Fannie Mae, a major player in the mortgage market, outlines how this works.

When can you request PMI removal?

You can request that your loan servicer terminate PMI once your loan balance reaches 80% of your home’s original value. Your lender provided you with an amortization schedule when you bought your home. This schedule shows you exactly when your loan balance is projected to hit that 80% mark. Keep an eye on this date and your loan progress, as it’s often when you become eligible to remove PMI.

Automatic PMI termination

Even if you don’t request it, your PMI may be automatically terminated when your loan balance reaches 78% of your home’s original value. However, to avoid paying more than necessary, it’s best to contact your loan servicer as soon as your balance reaches 80% to see if you qualify for early termination.

Requesting termination based on the current home value

If your home’s value has increased significantly since you bought it, you might be able to remove PMI sooner based on its current market value. To explore this option, reach out to your loan servicer to discuss their specific requirements and the process for terminating PMI based on increased home equity.

How much is PMI?

Just like other types of insurance, PMI rates can change daily. So, how do you figure out what you might pay?

Here’s how to calculate your estimated PMI:

• Calculate your annual PMI: Multiply your total loan amount by the current PMI rate (remember to convert the percentage to a decimal).
• Calculate your monthly PMI: Take that annual PMI amount and divide it by 12. This gives you your estimated monthly PMI payment.

Private mortgage insurance example

Let’s put those numbers into perspective with an example. Imagine you’re buying a $400,000 home and your loan amount is the full $400,000. If your PMI rate is 0.75%, here’s how it breaks down:

• Annual PMI: $400,000 multiplied by 0.0075 (the decimal equivalent of 0.75%) equals $3,000.
• Monthly PMI: Dividing that annual amount by 12 months means you’d pay $250.00 each month for PMI.

This added monthly cost highlights why many homebuyers look for ways to avoid PMI if possible.

Key takeaways

• PMI protects the lender, not you: Private Mortgage Insurance (PMI) safeguards your lender if you default on your loan, and it’s typically required on conventional loans when your down payment is less than 20% of the home’s purchase price.
• Multiple strategies to avoid PMI: While a 20% down payment is the most direct route, other options to bypass PMI include using a “piggyback” second mortgage (80/10/10 loan), considering lender-paid mortgage insurance (LPMI), or utilizing specialized loans like VA loans (for eligible service members) or USDA loans (for eligible rural homebuyers).
• PMI can be removed after purchase: Even if you start with PMI, you may be able to remove it later. You can request termination once your loan balance reaches 80% of the original home value, or it may automatically terminate at 78%. Removal is also possible if your home’s value has significantly increased.

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