If you borrow more than 80% on a conventional loan, you will pay PMI. It could cost you hundreds of dollars every month. You pay it until you owe less than 80% of the value of your home. That could be a long time if you borrow 95% of the home’s value. Even with home appreciation, it could still cost you thousands of dollars in total. Luckily, we have a few ways you can avoid it.
Take a Piggy Back Loan With an LTV Over 80%
If you have decent credit, you may qualify for a piggyback loan. Rather than borrowing the full amount in one loan, you take out two loans. Let’s say you need $270,000 on a $300,000 home. You may be able to get what lenders call an 80/10/10.
You borrow 80% of the $300,000 in a first mortgage. This means your first mortgage would equal $240,000. That leaves $60,000 between the purchase price and the amount you borrowed. Next is the 10% piggyback loan. This loan would be for $30,000. The piggyback loan is a second mortgage. It counts as part of the down payment on the loan. The final $30,000 comes from you as a down payment. With a 10% down payment from you and a 10% down payment from the 2nd mortgage, you only need to borrow 80% on the first mortgage.
With this method, you’d have two mortgages to pay. Generally, you can get a decent interest rate on the second mortgage, which is comprised of just principal and interest. The first mortgage would include your principal, interest, taxes, and insurance. The one thing you would not have to pay is PMI.
Take a Subprime Loan With an LTV Over 80%
Conventional loans are the only loans that charge PMI. Government-backed loans, such as FHA and USDA loans charge mortgage insurance, but you pay that on any loan regardless of the LTV. Subprime loans offer loans with LTVs as high as 95% in some cases.
There isn’t a specific program lenders follow, as occurs with conventional loans though. In this case, you’ll just have to shop around. Check with various lenders in your area as well as online. You’ll find that lenders have a large variety of options available. Each lender will require a different credit score, down payment, and debt ratio. Find a loan that falls within your parameters while providing you with an affordable interest rate and closing costs.
Ask for a Seller Credit
If you don’t want a piggyback loan and a subprime loan is too expensive, you have one last option. Ask the seller for a seller credit. If he agrees, you can use this amount to pay the PMI in one lump sum. You’ll have to talk to the lender to determine the lump sum amount. Normally, they break the payment up over a series of several years, based on when your loan amount would equal less than 80% of the current value.
The lump sum insurance payment takes care of the PMI for the life of the loan. If you choose this option, you don’t pay any more money for it. However, you will pay the full amount. This is something to consider. Even though the seller pays the amount for you, you’ll pay it in a higher sales price as the seller needs to make up for the money he loses.
Keep in mind, this could mean you pay more for the PMI over the life of the loan. If you were to choose monthly insurance payments, you may get to cancel the insurance before you pay the full amount. You can cancel Private Mortgage Insurance in a few ways:
- Pay for a new appraisal if you know your home appreciated in value and your principal balance is paid down enough to be less than 80% of the higher value
- Ask for PMI removal once you make enough payments to hit less than an 80% LTV based on the amortization table provided to you at the closing
- Refinance the loan to get rid of the Private Mortgage Insurance
In any of these cases, you may cut the Private Mortgage Insurance payments short. If you take the lump sum option, you don’t get any money back if your loan hits less than 80% value before the predetermined date.
What Does PMI Do?
Before you decide how you want to handle your loan and hitting less than an 80% LTV, you should know what PMI does for you. In reality, it does not benefit you at all. You pay for the insurance, but the lender benefits from it. It’s a policy that covers the lender should you default on the loan.
History shows that borrowers with an LTV higher than 80% are a higher risk of default. Lenders protect themselves from this risk with the insurance policy. If you do default, the lender can make a claim on the insurance, making up for the loss they experienced. The insurance would then cover a large portion of the amount you did not pay.
Should You Avoid PMI?
The bigger question is whether you should avoid PMI or not. It really depends on your situation. If you can afford the second mortgage, take the piggyback loan. This is the easiest way to avoid the insurance payments. Remember, though, you’ll likely have to put down 10% of your own money. Most lenders won’t give more than an additional 10% on the 80% first mortgage.
If you can’t afford the 80/10/10, consider a subprime loan or negotiating with the seller. It really depends on how long you plan to stay in the home. If this is not your forever home, the lump sum payment does not make sense. You’ll overpay for insurance that you don’t need.
Give the situation careful thought and weigh all of your options before deciding the right route to take.