"I LOVE paying for Private Mortgage Insurance!" said no homeowner, ever. PMI drives up mortgage payments and can stretch your budget to an uncomfortable limit. Adding insult to injury, this insurance does nothing to protect you, the homeowner -- it's there to protect the lender if you default. Here are several tips that could help you avoid paying for mortgage insurance premiums when purchasing your next home.
What Is PMI Anyway?
When home buyers purchase property with a small down payment, the lender takes a pretty big risk. That's because if the borrower defaults and the property goes into foreclosure, it's likely to sell for less than what's owed. (Foreclosure buyers pay in cash and they buy at a discount.) Mortgage insurance, called MI, private MI or PMI, protects lenders from losses by insuring some percentage of the loan amount, usually 25 percent for a 90 percent home loan. Here's an example.
- You buy a house for $100,000 with 10 percent down and a $90,000 mortgage.
- The lender requires you to buy PMI with 25 percent coverage.
- You don't pay your mortgage. The home is foreclosed and sold at auction.
- The PMI coverage is 25 percent of the loan amount. Twenty-five percent of $90,000 is $22,500.
- $90,000 - $22,500 = $67,500. As long as the property sells for at least $67,500, the lender won't lose money.
If you're unable to put 20 percent down when purchasing your home, chances are good that your lender will require you to buy PMI coverage.
The amount you pay for PMI depends on your credit rating, loan-to-value ratio and the percentage of coverage your lender requires you to buy. For example, Genworth mortgage insurance offers coverage of 30 percent, 25 percent and 16 percent for 95 percent mortgages. The more coverage there is, the safer the loan is for the lender -- and the more expensive the premiums are for you.
Compare the Total Package When You Shop Mortgage Rates
Government loans like FHA, USDA (Rural Housing) and VA home loans don't have PMI, but government agencies do charge to insure the loans -- these charges are called "funding fees" or "mortgage insurance premiums" (FHA MIP). Their coverage is mandated by law, so it costs the same for everyone. Fannie Mae and Freddie Mac, the huge government-sponsored enterprises that buy loans from lenders and sell them to investors, also impose minimum coverage requirements. You can't negotiate coverage for these loans. However, there are ways to pay less for MI, or even nothing.
- Some lenders waive PMI or offer reduced coverage for very strong applicants. Credit unions may do this for members in good standing who have excellent credit.
- Some lenders may purchase the coverage for you by paying a lump sum upfront. This coverage is called LPMI (lender paid mortgage insurance). When lenders pay for mortgage insurance, though, they charge you a higher interest rate.
- Some lenders choose to "self-insure," which means they don't make you buy mortgage insurance at all. Many sub-prime lenders used to operate this way. Of course, when the lender assumes more risk, it charges a higher interest rate.
- Fannie Mae's My Community Mortgage and Freddie Mac's Home Possible are 97 percent community mortgage products that come with reduced MI -- 18 percent coverage instead of the 35 percent normally required for 97 percent loans. This product is limited to home buyers with low- to-moderate incomes.
Whenever you compare quotes from mortgage lenders, look at the loan's APR, or annual percentage rate, and the total monthly payment. One lender might offer a really low interest rate but require expensive MI coverage; another might charge a higher rate but with less MI. It's the total cost you need to compare. LoanExplorer by LendingTree lets you easily make these comparisons.
What if You Have Bad Credit?
Having poor credit isn't a barrier to homeownership. Having poor credit just makes owning a home much more expensive. FHA loans have more flexible underwriting guidelines, and allow down payments of 3.5 percent (for applicants with credit scores of at least 580) or ten percent (for applicants with credit scores of at least 500). FHA charges both an upfront mortgage insurance premium and a monthly fee -- it's some of the most expensive mortgage insurance you can buy.
Can You Cancel Private Mortgage Insurance?
If you're up to date on your monthly payments, you may be able to remove your PMI. Once you have sufficient equity in your home, meaning your mortgage balance dips below 80 percent of the home's appraised value, you can request (in writing) that your lender cancel your PMI. You may be required to pay for an appraisal at the time of your request to prove that your home has not decreased in value.
If you don't make this request, the law requires the lender to automatically terminate coverage when the balance drops below 78 percent of the home's original purchase value. If you have questions about your ability to request cancellation or have your PMI terminated, contact your lender.
Unfortunately, these guidelines for cancellation and termination do not apply to FHA mortgage loans. If you took out your FHA home loan after June 3,, 2013, you will be required to pay MIP for the entire life of the mortgage.
If you're stuck with FHA required mortgage insurance right now, you can clean up your credit, build equity in your home and refinance to a traditional (and much cheaper) home loan. The best way to avoid PMI is to make a higher down payment, shop with many lenders and clean up your credit.