3 Ways to Not Pay Private Mortgage Insurance

Private Mortgage Assurance (PMI)

I often hear that homebuyers, and homeowners want to avoid mortgage insurance on their home loan.

I’m not sure how private mortgage insurance (PMI) got such a bad rap, and I would like to explore and explain what a powerful and beneficial tool it can be when purchasing, or refinancing your home loan.

The reason that private mortgage insurance exists is that many years ago Fannie Mae determined that 80% loan to value is the maximum amount of risk that the lender is willing to take without insurance.

What is Private Mortgage Insurance (PMI)?

Private mortgage insurance is essentially an insurance policy that covers the lender against default.  If mortgage insurance didn’t exist, you would need a 20% minimum down payment to purchase or refinance your home.

The Real Value of Private Mortgage Insurance

Another way to look at PMI is as the cost to borrow the difference between 80% and the amount of down payment you have.  Looking at it that way, it’s the cheapest money you will ever borrow!

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With an average PMI rate between .50% and .85%, it’s far less expensive than any personal loan or credit card terms. Even if you have the money available for down payment, investing that money into your home equity essentially makes it untouchable and potentially very expensive in the future.

By keeping your reserves as reserves, you are more fluid and flexible in the event that you need access to that money.  The cost of investing that money into equity has the future risk of higher interest rates when you have to refinance to get that money out.

How to Avoid PMI – 3 Ways to Not Pay Private Mortgage Insurance

Just because you shouldn’t fear PMI doesn’t mean that you should be happy about paying it either.  There are several ways to get out of PMI at the time of purchase if you make less than a 20% down payment.

1. Excellent Credit Programs.

Normally, the private mortgage insurance cost is rolled into your interest rate, resulting in a slightly higher rate over the long term of your loan.  For borrowers with a 760 credit score or better, these programs offer reduced interest rates so that by the time you calculate in the cost of the PMI, the interest rate is the same or lower than a borrower with a score of below 760.

These programs will go all the way up to 97% loan to value for qualified borrowers in low to moderate income price ranges.  This price range is generally limited to the conforming loan limit in your County.

2. Piggyback Mortgage

There is a resurgence of second mortgages, and home equity line of credit programs on the market for buyers with as little as 10% down payment.  These programs allow you to take an 80% loan to value first mortgage, and avoid private mortgage insurance, and take out a second mortgage, or home equity line of credit to bridge the gap up to 89.99% loan to value.

Piggyback mortgages are usually reserved for higher credit score borrowers, however, there are programs available under double-digit interest rates, for borrower with lower credit scores.  Expect that the lower your credit score, the lower the maximum loan to value is on your second mortgage or HELOC.

3. Buy Out PMI (Private Mortgage Insurance)

Most lenders can offer a buy-out option for conventional mortgages with private mortgage insurance (sometimes called single-premium mortgage insurance or single-payment mortgage insurance.)  This buyout is based on your credit score, and the loan to value of the transaction.

How Much Will It Cost To Buy Out My PMI?

Buying out your PMI can be as expensive as 3.29% of the loan amount with 5% down and a 680 credit score, or 1.92% with a credit score of 760 in the same scenario.  (On a $300,000 mortgage, those costs would be $9,870 and $5,760 respectively.) This is your FICO range perspective.

With FHA mortgage insurance, you pay the same rate of .85%, no matter what the loan to value.  With private mortgage insurance on a conventional loan, your rates are reduced as your loan to value is reduced.  An example of finding an affordable sweet spot might be with 10% down and a 760 FICO, the buyout is only 1.37% of the loan amount. If you’ve only saved up 15% down payment, your buyout is under 1%.

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The money to pay for this buyout can come from a seller credit and/or a lender credit, it does not have to come out of your pocket.

When Buying Out PMI / Paying For Single-Premium Mortgage Insurance Is Not A Good Idea 

It may not be a good idea to buy out your private mortgage insurance / pay for single-premium mortgage insurance if:

• Doing so will use up a significant portion of your cash reserves, which may be needed for unexpected repairs as you move into a new home
• If you’re planning on doing significant renovations/remodeling to the home shortly after moving in. Those renovations may increase the value of your home enough to have its loan-to-value ratio be less than 78%, which will enable you to stop paying PMI
• If you foresee high housing price inflation in your market, which again can rapidly increase your home value to the point where you won’t need to pay PMI
• If you plan to move out of or refinance your home in the next 2-5 years
• If you’re concerned about the tax ramifications – Single-Premium Mortgage Insurance fees are not currently deductible on your taxes

Which Option To Eliminate PMI is Best for Me?

That’s a great question and can be answered in many different ways. The best option for you will depend on how much or how little you want to invest in your down payment and your credit scores.

If you fall into one of the above categories, your path is usually laid out for you and is quite obvious.  If you’re still not sure what the best option is for you, let’s take a look at approaching this from another angle.  Let’s look at your options based on your down payment.

5% to 10% Down Payment – It will be difficult to avoid mortgage insurance in this down payment range.  While the second and third way to not pay mortgage insurance do apply to this range, it tends to be too expensive or difficult to source an investor.  Weigh all of these options, and if none work, consider FHA financing.  With only 3.5% down, it is the most cost-effective money you can get with credit between 640 and 680.

10.01% Down Payment – At 89.99% loan to value, we now have piggyback options available to keep your first mortgage limited to 80% loan to value and putting the remaining nearly fifteen percent on a second mortgage or home equity line of credit (HELOC).

This program typically requires higher credit scores, although there are non-traditional investors that offer second mortgages at above market rates to lower scores.

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Again, weigh all of these options, and if none of them work, consider FHA financing.  With only 3.5% down, it is the most cost-effective money you can get with credit between 640 and 680.

15% Down Payment – At 85% loan to value, the cost to buy out mortgage insurance is very reasonable.  If you can get a lender credit or a seller credit to cover the cost of buying out the PMI, then you don’t pay for mortgage insurance…they do!

Working With a Creative Lender

These programs are not available to all lenders.  If you have to suggest one of these options to your lender, you may want to find a lender access to excellent credit programs, second mortgages, or home equity lines of credit.

Some of these options require that your lender have a little creativity.  The more experienced your loan officer is, the more likely you will be presented with creative options.

As an empowered consumer, you can now make interviewing and hiring the right loan officer much easier.  Now that you know what you’re looking for, you know what to ask for.

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