Why Private Mortgage Insurance is Required on Some Mortgage Loans
If you're just starting out, coming up with 20% down is hard enough! Throw in closing costs and your head starts spinning.
It's no wonder. Buying and selling real estate is expensive, an expense most people aren't prepared for.
One of those expenses is private mortgage insurance. What is it? And why do you have to pay it?
We take a deep dive look at the mortgage insurance nobody likes but is required under certain conditions.
Private mortgage insurance, or PMI, is used for conventional mortgage loans with less than 20% down. It protects the lending company if you stop making your mortgage payments.
PMI can be provided by a private insurance company or by the lender. If you are required to pay PMI, it will make up a portion of your monthly home investment. Just like property taxes, interest, and homeowner's insurance, PMI does not build equity in your property.
"What's the difference between PMI and MIP?"
There are two types of mortgage insurance. One is bought from the federal government and is designed for FHA loan borrowers. It's called Mortgage Insurance Premium, or MIP.
PMI, on the other hand, is purchased through the private sector for a conventional loan. Each has its own set of rules with MIP handled and run differently than PMI.
Mortgage Insurance Premium or MIP is purchased for an FHA government-backed loan.
Private Mortgage Insurance or PMI is purchased for a conventional loan with less than 20% down.
"Why am I required to have PMI?"
When a borrower has less than 20% down on a conventional home loan, the lender requires PMI. Usually, private mortgage insurance premiums are paid until you have a loan-to-value ratio of 80%.
For example, if you put 10% down on a $100,000 home. That's a loan-to-value of 90%. The longer you own your home, the lower your LTV, which makes a borrower less risky in the eyes of the lender because of the equity.
Once you have an LTV of 80%, PMI can be released. If you were to default on the home at this point, the lender has a better chance of selling the property at foreclosure for at least as much as they were owed.
"How can I avoid paying PMI?"
Generally, you must have 20% down to avoid PMI. However, in 2016, Bank of America in partnership with Self-Help Ventures Fund and Freddie Mac, launched the "Affordable Loan Solution" mortgage.
This is a conforming loan for low and moderate income homebuyers. It allows for a down payment of 3% with no PMI.
- Qualified veterans who apply for a VA loan with 100% financing (no down payment) don't have to pay PMI, either. However, an upfront funding fee may be required. There are, however, some certain veterans that are exempt from this fee.
- For strong applicants, some credit unions will waive the private mortgage insurance premium.
- There are some lenders that offer non-conforming and portfolio options with no PMI required.
- Lastly, physician loans typically don't require PMI on mortgage loans with less than 20% down.
What about the piggyback option?
A final option for avoiding PMI is to get what is called as a "piggyback" loan. This is a smaller loan that covers the 20% down payment, allowing you to avoid paying private mortgage insurance.
Typically, though, the smaller loan will have a higher interest rate. The benefit is you can usually deduct that interest on your tax return. The bigger question to consider may be whether you can afford to pay a second loan for X number of years.
In the end, you have to weigh what's best for you and your financial situation. Seek out a tax advisor or financial planner, if need be.
Lilly Title & Settlement is a woman-owned, full service title insurance and settlement company in Staunton, VA. We serve not only Staunton, but Waynesboro and Augusta County. If you've got questions title insurance or closing on your home, please give us a call. We're happy to help! 540-414-8763.