Mortgage Loan Insurance: What Is PMI and How Can You Avoid It?

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**Mortgage Loan Insurance: Understanding PMI and Strategies to Avoid It**

Home-buying can be one of the most significant investments in a person’s life, and it often involves navigating complex financial decisions—one of which is dealing with mortgage loan insurance, commonly known as Private Mortgage Insurance (PMI). Let’s break down PMI and discuss strategies for avoiding this extra cost.

**What is PMI?**

Private Mortgage Insurance is a type of insurance policy that protects the lender from losing money if the borrower ends up defaulting on their mortgage. PMI is usually required when a homebuyer opts for a conventional loan and makes a down payment that is less than 20% of the home’s purchase price. Essentially, PMI lowers the risk for the lender, facilitating mortgages for buyers who cannot afford a substantial down payment.

Though PMI is for the lender’s benefit, it is the borrower who pays the premiums. These payments are generally made monthly and are included in the mortgage payment. The cost varies but typically ranges from 0.3% to 1.5% of the original loan amount per year depending on the size of the down payment and the borrower’s credit score.

**The Impacts of PMI**

Having PMI means your monthly mortgage payments will be higher. Over time, PMI can add a significant amount to your housing costs. For instance, on a $200,000 mortgage with a 1% PMI rate, you could be paying an extra $2,000 a year, or approximately $166 per month. PMI does not contribute to your home equity, so it’s a cost many wish to avoid or minimize.

**How Can You Avoid PMI?**

The easiest way to avoid PMI is to make a down payment of at least 20% on your home. But for many homebuyers, particularly first-time purchasers, saving enough money to reach that threshold can be difficult. There are several other strategies to avoid or diminish the burden of PMI:

1. **Opt for a Different Loan Type:** Government-backed loans like a VA loan or FHA loan might not require PMI. VA loans, for veterans and service members, require no down payment and no PMI. However, FHA loans include a Mortgage Insurance Premium (MIP) which is similar to PMI but typically lasts for the life of the loan on down payments less than 10%.

2. **Lender-Paid Mortgage Insurance (LPMI):** With LPMI, the lender pays your PMI in exchange for a higher interest rate on your mortgage. This can save you money in the short-term if you plan to sell or refinance within a few years but could end up costing more over the life of the loan.

3. **Piggyback Loan:** Also known as an 80/10/10 loan, the piggyback strategy involves taking out a second mortgage (like a home equity loan) at the same time as the first mortgage. This second loan (typically 10% of the home’s price) is combined with a 10% down payment to circumvent PMI since the first mortgage only constitutes 80% of the home’s price.

4. **Pay Attention to Home Equity:** Once your mortgage balance is less than 80% of the home’s value, either through payments or improvements to the house that increase its value, you can request that the lender cancel the PMI. Additionally, the Homeowners Protection Act mandates automatic cancellation of PMI once the mortgage balance reaches 78% of the original value of the home, provided you are current on your payments.

5. **Accelerated Mortgage Payments:** By paying more than the minimum mortgage payment each month, you can increase your home equity faster and reach the 80% threshold sooner to request the cancellation of your PMI.

6. **Look for PMI Discounts:** Some lenders may offer discounts on PMI if you take a homeowner education course or have a particularly strong credit history. It’s worth asking potential lenders about any discount programs they might offer.

7. **Refinance Your Mortgage:** If your home value has increased, you may refinance your mortgage for less than 80% of the new appraisal value, potentially getting rid of PMI in the process. This strategy works best when interest rates have dropped since your original loan was made.

**Things to Consider Before Choosing a Path to Avoid PMI**

While avoiding PMI can save you money, there are trade-offs. Here are things to consider before pursuing any of the above strategies:

– Larger down payments can significantly deplete savings that might be needed for home repairs or emergencies.
– Government-backed loans may have their own insurance fees that might exceed the cost of conventional PMI over time.
– LPMI and piggyback loans can sometimes lead to higher interest payments than what you would have paid in PMI.
– Additional mortgage payments or refinancing incur new closing costs and can extend the term of your indebtedness.

**Conclusion**

Navigating the intricacies of PMI can be overwhelming for homebuyers. Nevertheless, by understanding what PMI is, how it impacts your mortgage payments, and exploring the various strategies to avoid it, you can potentially save thousands of dollars over the life of your loan. Always run the numbers carefully, considering both short-term affordability and long-term costs, and seek advice from financial advisors or mortgage professionals to make the most informed decision regarding PMI and your home purchase.

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