When purchasing a home and applying for a mortgage, many borrowers are confronted with the dreaded Private Mortgage Insurance (PMI) requirement. PMI is typically mandated when borrowers put down less than 20% of the home's purchase price as a down payment. While PMI serves a purpose by protecting lenders in case borrowers default on their loans, it can be an additional financial burden for homebuyers. Fortunately, there are several alternatives to PMI that can help borrowers avoid this expense while still achieving their homeownership dreams.
Increase Your Down Payment
The most straightforward way to avoid PMI is to make a larger down payment. Lenders typically require PMI when the down payment is less than 20% of the home's value. By saving up and putting down a more substantial amount upfront, you reduce the lender's risk, making PMI unnecessary. While this approach may take longer to accumulate the necessary funds, it can save you thousands of dollars in PMI premiums over the life of your mortgage.
Another option to sidestep PMI is to use a piggyback loan. A piggyback loan is a second mortgage taken out simultaneously with the primary mortgage. It covers a portion of the down payment and allows borrowers to reach the 20% threshold required to avoid PMI. Common piggyback loan options include the 80-10-10 and 80-15-5 structures, where the first number represents the primary mortgage percentage, the second is the second mortgage, and the third is the down payment percentage.
For example, with an 80-10-10 loan, you would put down 10% of the home's purchase price, obtain a primary mortgage for 80%, and take out a second mortgage for the remaining 10%. This creative financing technique can save you from PMI while potentially offering a lower overall interest rate on the second mortgage compared to PMI premiums.
Lender-Paid Mortgage Insurance (LPMI)
Lender-Paid Mortgage Insurance (LPMI) is an alternative in which the lender pays the PMI premiums on your behalf. In exchange, you agree to pay a higher interest rate on your mortgage. While this can be an appealing option for borrowers who prefer not to make a larger down payment or manage a second mortgage, it's essential to calculate the long-term costs carefully. LPMI can end up costing more over the life of the loan compared to paying PMI separately.
VA and USDA Loans
If you're eligible for a VA (Department of Veterans Affairs) or USDA (U.S. Department of Agriculture) loan, you can secure a mortgage without PMI, regardless of your down payment amount. VA loans are available to veterans, active-duty service members, and certain members of the National Guard and Reserves, while USDA loans are designed for rural and suburban homebuyers with limited income. These government-backed loan programs offer competitive interest rates and often do not require a down payment.
Lender Loyalty Programs
Some lenders offer loyalty programs that allow you to avoid PMI. These programs may involve opening a specific bank account, maintaining a certain balance, or having an existing relationship with the lender, such as holding other accounts or loans with them. Lender loyalty programs can be a win-win, as they incentivize borrowers to consolidate their financial services while potentially waiving PMI.
"HomeReady" and "Home Possible" Loans
Fannie Mae's "HomeReady" and Freddie Mac's "Home Possible" programs are designed to help low-to-moderate-income borrowers secure mortgages with reduced down payment requirements and competitive interest rates. These programs may permit down payments as low as 3%, making them an attractive alternative to PMI for eligible borrowers.
Wait and Refinance
If you initially obtain a mortgage with PMI but anticipate your home's value will increase or your financial situation will improve over time, you can wait and refinance your mortgage later. Refinancing allows you to secure a new loan with a lower loan-to-value ratio, potentially eliminating the need for PMI. Keep in mind that this strategy depends on market conditions and your ability to qualify for a new mortgage.
Private mortgage insurance isn't the only path to homeownership when you have a smaller down payment. By exploring these alternatives, you can make an informed decision that aligns with your financial goals and circumstances. Whether you choose to increase your down payment, leverage piggyback loans, or explore specialized loan programs, there are viable options to avoid PMI and make your homeownership dreams a reality.