A mortgage is one of the major investments that you make when you settle down in your dream house. Yes, it does come with other costs too. You pay your mortgage loan, the interest, Private Mortgage Insurance also called PMI and other processing expenses as well. Sounds quite overwhelming, doesn’t it?
What is PMI?
Private Mortgage Insurance is commonly known as PMI. PMI is the insurance policy that is paid by you to offset the lender’s risk. It protects the lender in case the borrower defaults and in foreclosure of the property. PMI is expensive. PMI fees range from around 0.3% to 1.5% of original loan amount per year, depending on your down payment, LTV, credit score, etc.
As your monthly debts already increase when you pay mortgage and interest, you would want to be saved from paying the PMI. PMI fee is almost equal monthly car loan on average house values. Here are some tricks to help you avoid paying PMI.
- A Substantial Down Payment at the Time of Closing Can Help You Out
PMI reduces the risk for the lender, and so does a hefty down payment. If you pay 20% of the purchase price of your home as down payment, your lender will probably waive PMI. A considerable down payment amount reduces the possibility of default, providing security to the lender.
This is the easiest way to avoid PMI. But do not worry if you don’t have enough savings for a bigger chunk of down-payment. There are still ways to avoid PMI, even with a 10% down payment.
- Having a Loan-to-Value Ratio (LTV) of Not More than 80% Saves You
LTV is the ratio between the mortgage loan and the home value. The formula for LTV is LTV = Mortgage amount owed / Appraise value of property
For example, if you owe $60,000 on the mortgage loan and the house value is $100,000, then your LTV ratio is 0.60 and LTV percentage is 60%. The key to avoiding PMI payment is having an LTV ratio equal to or lower than 80%
Paying a higher equity for your house lowers LTV ratio. If your LTV ratio is higher than 80% you will be subject to PMI.
- A Good Credit History Will be Your Friend
Credit history matters a lot in loan processes. A good credit score and smooth credit report can save you from PMI. Borrowers with bad credit history are a major risk for lenders. They may require borrowers to pay PMI in such cases.
Pay your debts on time; acquire a good credit report, to prove your creditworthiness in the eyes of the lender.
- Debt-to-income Ratio, the Lower the Better
A lower ratio between your debts and gross monthly income makes you a steady borrower. This stability helps you in winning flexibility in mortgage activity. Having enough credit to pay your debts easily can help you in avoiding PMI.
- Piggy Bank Mortgage
You take out a second home equity loan in this case aside from your original mortgage loan. Piggy bank mortgage usually works like 80-10-10 formula. Where 80% of the purchase amount is covered by a first mortgage loan, 10% with the second loan and 10% is paid as down payment.
When the LTV of the first loan is equal to 80%, then PMI is eliminated. So yes, with the division of loan you can avoid PMI and get a low-interest rate too.
Some lenders also offer this type of loan arrangement for 5% down payment as 80/15/5 agreement.
- Lender Paid Mortgage Insurance (LPMI):
The lender pays the insurance premium and covers the cost by increasing the interest rate over the life of the loan. LPMI chases away monthly PMI payments, but it does increase the interest rate on a mortgage payment. LPMI can increase the interest rate from 0.25 to 1% depending on circumstances.
LPMI is also affected by your LTV ratio and credit scores.
What If You are Stuck with PMI Already?
Good news for you comes with the Homeowners Protection Act of 1998 law that PMI will automatically terminate when homeowners reach 78% LTV or pay 20% home equity based on original value. This law covers mortgage loan signed after 29 July 1999.
Prior to this law, lenders did not notify borrowers about LTV falling below 80%. Now homeowners can easily file a request for termination of PMI, or an automatic termination is carried out. Keep a check on your loan amortization schedule to waive away this burden. This law compels loan services to cancel PMI if it is not terminated automatically or as per the borrower’s request.
With our detailed account on saving yourself from PMI, hopefully, you will be successful in acquiring your cozy abode without much trouble.