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January 10, 2020
January 10, 2020
You know you need to pay homeowner’s insurance when you purchase a home. And for good reason: that policy protects you should anything unexpected happen to your property.
As expensive as homes can be to keep, maintain, and repair, the right home insurance is a great investment in your long-term financial security. If something goes wrong, you won’t be on the hook for 100% of the cost that it takes to put everything back in place.
But there’s another type of insurance on your home that you may not know about — and it’s not quite as helpful to you as homeowner’s insurance.
It’s called private mortgage insurance, or PMI. As the name suggests, this insurance applies to your mortgage.
Whereas homeowner’s insurance protects you and your home, PMI protects your mortgage lender. Here’s how it works:
Let’s say you take out a mortgage with a lender. They decide to approve your request and agree to originate a loan for you. But you don’t have enough or a full 20% down payment on the home. To protect themselves in case you stop paying your mortgage or default entirely on your mortgage, the lender requires you to pay monthly for private mortgage insurance (PMI) on your loan. This insurance policy will pay out to the lender if you default on your loan.
That means the lender can recoup some or all of the money they let you borrow. But keep in mind this insurance does not protect you, the borrower. PMI is designed to protect the lender, and the lender is the one who requires it in cases where the borrower doesn’t have 20% down.
But you’re on the hook for paying the premiums each month. It’s part of your monthly mortgage payment along with the principal and interest on your loan and homeowner’s insurance and property taxes.
PMI is almost always required if you don’t have enough money to put 20% down on the home.
There is some good news: if you need PMI, you should know that you can likely remove the monthly PMI payments when you reach at least 20% equity in your home. At that point, you can call your lender and request PMI be taken off your mortgage.
Private mortgage insurance can cost around $30-$70 per month for every $100,000 you borrow, That’s no small number and it’s an avoidable cost if you know the steps to take.
The first and most straightforward way to cut out PMI? Make a 20% down payment on the home you want to purchase.
This means you finance 80% of your home with a mortgage. Lenders see that as less risky than if you put down anything less, so don’t charge PMI to protect the money they let you borrow.
But 20% of a home’s purchase price can be a lot of cash. Many buyers simply don’t have this money on hand and available to put down when they take out a mortgage.
You could try getting a different type of mortgage to avoid the PMI if you don’t have 20% to put down. For example, an 80/10/10 mortgage or piggyback loan, allows you to take out a mortgage for 80% of the home’s cost. Then, you take out a second loan on top of the mortgage for 10% of the cost to combine with 10% you put down in cash. That’s where the “80/10/10” breakdown comes from.
This can help you avoid PMI since the mortgage lender ends up receiving the full 20% down payment in cash (which is made of the money you got from the second loan and your own cash).
Piggyback loans are helpful if the interest and origination fees on that second loan are less than what you would pay in PMI each month.
Make sure you run the numbers in your specific situation to determine which way saves you the most: putting 10% down on your mortgage and paying PMI, or taking out an 80/10/10 mortgage and paying the additional loan origination fee plus interest on the second loan.
Another way to avoid PMI is to ask your lender to pay for it. This is called Lender Paid Mortgage Insurance (LPMI) and it usually comes with a higher interest rate. While this sounds like an appealing option at first glance, there is a significant possibility that it could cost you more in the long run due to the higher interest rate.
There’s also a third option to avoid PMI if you don’t have the full 20% of your home’s price in cash to use as a down payment and you don’t like the idea of getting a piggyback loan.
It’s something called a home ownership investment. Companies like Unison offer programs that allow you to receive cash for a down payment in return for a share of the future change in the home’s value. If you have enough for a 10% down payment, the company will contribute another 10% so you can put a full 20% down. The money provided is not debt. There are no monthly payments or interest charges. You can use the money for up to 30 years until you sell your home. Meanwhile, your monthly mortgage payments still go toward building your equity in the home.
Paying PMI may make sense depending on your situation. You can still buy a home with 10% down and include PMI in your budget for monthly mortgage payments. If the fee is manageable, you might prefer to pay it until you have at least 20% equity in your home rather than put off your dream to own a home.
But buying a home without incurring charges from PMI is possible — even if you don’t have 20% of your home’s purchase price to use as a down payment.
Explore all the options available to you, including different loan types and home ownership investment, to purchase your home even with a smaller down payment and still avoid PMI.