In my previous article we looked at mortgage insurance, or PMI, and how you can stop paying it. Today we will look at different approaches to financing or refinancing a home that avoid PMI from the start.
Remember that PMI is added to a conforming mortgage loan when you buy a house with a down payment smaller than 20% of the purchase price, and can easily add $50, $100, or more to your monthly payment. The obvious and best way to avoid PMI is to put down 20% when you buy the house. But many people don’t have the 20%, or don’t want to tie that much cash up when they first buy a house. If you fit in that category, then you should consider these options. There are pros and cons to each approach, so there is no single option that’s best for everyone. Think about your personal bill paying and financial planning habits, and how long you plan to stay in the house, before deciding on the option that’s best for you.
1) Get an 80/20 loan – This is actually two separate loans. The first loan is a conforming mortgage loan for 80% of the purchase price, which by definition does not require PMI. You then get a second mortgage loan to cover the rest of the money needed to purchase the house. The second loan can be for 20% or less, depending on the down payment you plan to pay. Second mortgages never require PMI. Pros: the combined monthly payment is lower, even with the higher rate on the second loan, and all of the interest may be tax deductible. (PMI is not tax deductible.) Cons: You’ll get a competitive rate for the main 80% loan, but second mortgages carry higher interest rates, currently about 10%, and you have to make two payments each month. Also, PMI can be removed after you reach 22% equity, but you’re stuck paying the higher interest second mortgage until you pay it off, no matter how much your house appreciates in value.
2) Get a non-conforming or sub-prime loan – Sub-prime lenders specialize in higher risk loans, like people with lower credit scores or no money down loans. Because these loans do not conform to FNMA guidelines anyway, they do not require PMI. These lenders do charge higher rates to offset the risk, but if you have good credit the increase in rate may be negligible. Rates vary based on each borrower’s situation, so compare this to your other options before making your decision.
Article comments
1 - Joshua Bucio
It's good to see others are sharing ways to avoid PMI. Let's face it, no one wants to pay PMI.
I've also listed 5 ways to avoid or lower your PMI payment.