How To Avoid Paying Mortgage Insurance

Mortgage insurance — also called private mortgage insurance (PMI) is an insurance policy that mortgage lenders will ask you to take out to protect them in the case you default on your mortgage. This way they make sure that your home will have enough equity to pay off the loan balance should you default and go into foreclosure. As a result, you will have to secure a private mortgage insurance prior to signing off on the loan. Avoiding mortgage insurance is not always possible. However, the good news is that prospective home buyers have several options in case they do not want to pay mortgage insurance. Read on to find out whether you can avoid PMI on your mortgage

What Is Mortgage Insurance?

Mortgage insurance is a mandatory insurance policy; a protection against a loss. PMI (private mortgage insurance) offsets the lender’s risk; your mortgage lender requires this so they may receive reimbursement in case of default. Mortgage insurance comes in two basic varieties with two similar-sounding names.

1. Private Mortgage Insurance for conventional loans is purchased from the private sector which is commonly called PMI.
2. Mortgage Insurance Premium for FHA loans is purchased from the government commonly called MIP

Private mortgage insurance is offered by private companies and is linked to conventional mortgage lending.  Fannie Mae or Freddie Mac backs these loans.  As opposed to the government agencies which insure FHA or VA loans. Fannie Mae and Freddie Mac require an accompanying mortgage insurance policy whenever a home's equity percentage is less than 20%. Usually, the lower your down payment and/or the lower your credit score the higher your PMI payment will be.

How to Avoid PMI:

• Make a down payment of at least 20 percent

The easiest way to avoid PMI is by making a down payment of 20 percent or more.  However, you should take into consideration that the average savings rate in U.S. is currently around 5%. The funds for down payment can also be a gift from a member of your family; as long as you have a minimum of 20% down payment PMI won't apply. For home loans that don’t have the magic down payment percent of at least 20%, you will need PMI. The insurance offers protection to the investor who is backing the mortgage on the secondary market.  The homeowner pays for the mortgage insurance.  It is necessary until your home's equity reaches 20% of your home's market value. Mortgage lenders need that buffer of at least 20% to be sure they will recover the money they loan in the event that a property forecloses and sells for less than the original price.  

• Use second mortgage financing

If you do not have the standard 20% of the sales price or value of the desired property to put down as a down payment there still is an alternative to paying PMI. You could use a second mortgage also known as a piggyback loan. The first mortgage must be capped at 80 percent & not exceed conforming loan limits of the home’s value to avoid PMI, while simultaneously using a second mortgage for another 10-15 percent and the final 5-10% is covered by the borrower's down payment. It is also possible for lenders to agree to an 80-5-15 loan or to an 80-15-5 mortgage. As an added advantage, when using a piggyback loan you can deduct the interest you pay on both mortgages. Just take into consideration that the mortgage on the second loan is deductible up to the first $100,000 and that it has a higher interest rate than a single, stand-alone first mortgage.

• Finance through FHA

If you qualify for a VA loan and you do not want to pay a PMI you could go in that direction. The VA loan offers several advantages such as a low down payment as well as lower closing costs. VA guarantees the loan and does not charge mortgage insurance. You should take into consideration that FHA charges an up-front premium that you will have to either pay at closing or you can opt to have it financed into your loan and increase the debt amount.  Also, VA charges and up-front funding fee that you can opt to have financed directly into your loan.  Almost ALL FHA & VA borrowers opt to have their up-front MIP & up-front funding fee financed into the loan. Connect with your mortgage broker to work out the numbers. Casey Moseman can help you determine the value of the trade-off regarding the risk and the best way to reduce your payment obligation regarding the total payments.