How to Lower PMI with Less than 20 Percent Down

Mortgage insurance is required of all consumers taking a loan on a home on which they cannot afford at least a 20 percent down payment. The insurance offsets risks posed to the lender. In conventional mortgages, borrowers have a choice of paying for private mortgage insurance or accepting lender-paid mortgage insurance (LPMI). In choosing between the two, borrowers should consider their financials wisely since there are pros and cons to each, with lasting effects.

Borrowers seeking an FHA loan who cannot afford a 20 percent down payment are required to pay mortgage insurance via the FHA Upfront Mortgage Insurance Premium (UFMIP) and the FHA annual Mortgage Insurance Premium (MIP). The current upfront FHA mortgage insurance premiums are rolled into the life of the loan, whereas annual premiums are collected monthly for the life of the loan, up to as long as 30 years. The only way to cancel mortgage insurance on an FHA loan is to refinance it with a conventional mortgage.

Understanding PMI and Long-term Costs on a Conventional Mortgage

First things first about the lender-paid option: Lenders may process the paperwork, but they do not "pay" for the LPMI. Unlike the protocol with the PMI, where the borrower receives separate monthly statements for the mortgage and insurance, the LPMI procedure rolls up the insurance into the total cost of the loan and has the consumer pay for the insurance through an increase in the mortgage rate.

The ultimate deciding factors concerning the choice between PMI and LPMI on conventional mortgages have to do with the length of time the owner plans to stay in the home and their income. A PMI plan may be better suited for homebuyers with a good credit rating concerned about the level of their monthly payments. PMI also offers borrowers the opportunity to drop their insurance once the loan-to-value ratio for the home reaches 78 percent. LPMI borrowers have already rolled the cost of insurance into the mortgage total. Hence, the LPMI payment remains until the home is refinanced or paid in full.

On the other hand, if the borrower runs the numbers, LPMI may make more sense for a homeowner that plans to stay with the property for only five years or less, eliminating the cost of insurance when they sell. For those who intend to keep their homes for more than a decade, the ability to roll off the PMI once the LTV ratio minimums are reached can be an incentive, hopefully along with increases in equity and value.

How to Lower or Avoid PMI

In comparing loan offers, consumers should examine the loan's annual percentage rate and total monthly payment requirements in calculating the loan's total cost. The total cost can be more important than the interest rate, depending on the term and type of required mortgage insurance. Higher insurance fees are typically balanced by lower interest fees for PMI, while higher interest rates that last the length of the loan on a LPMI may cost more in the long haul. The lower monthly payment generated by an LPMI has one benefit: borrowers may qualify for a larger loan.

One way to lower the requirements on mortgage insurance is to pay down more than 20 percent of the loan upfront. Lenders may allow consumers to reduce LPMI by paying down the rate through discount points. Another option while starting or refinancing a mortgage is to take out a second mortgage or home equity loan ("piggy back" mortgage) that lowers the LTV ratio below 80 percent to avert the PMI entirely. But there is the risk if the property value drops to where both loans go upside-down and the home cannot be refinanced. There can also be crushing balloon payments. Before considering a piggy back mortgage, borrowers should know that the smaller loan typically comes with higher interest rates than charged on the first mortgage. In short, the savings in avoiding PMI may be wiped out by the higher interest rate on the second mortgage.

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