Understanding Private Mortgage Insurance (PMI)

by Sandy Dodge

Buyers are constantly looking for ways to streamline the buying process, whether that’s working with their agent to identify how they can increase their buying power, getting pre-approved, or being as cash-ready as possible. Private Mortgage Insurance (PMI), though it is an additional expense, can be a gateway to homeownership, and for some buyers, may be their only choice to secure the required financing for a home.

What is PMI?

Understanding PMI begins with understanding down payments. A down payment is a lump sum payment made by the buyer early on in the process of obtaining a mortgage. The magic number lenders prefer to see paid down is usually twenty percent of the home’s purchase price. If a buyer doesn’t have that secured, the lender will typically require the buyer to purchase Private Mortgage Insurance (PMI), which protects the lender against the possibility of the buyer defaulting on the mortgage.

The Benefits of PMI

Fortunately, it’s not all-or-nothing when it comes to the twenty percent down payment—if you don’t have that amount on hand, you can still purchase a home. Private Mortgage Insurance creates a pathway to homeownership for buyers who find themselves in this situation. Although PMI can raise the buyer’s monthly costs, it allows them to move in and start building equity immediately. For this reason, PMI may be a saving grace for buyers who are looking to leave their days of renting behind them and become a homeowner.

Alternatives to PMI

Saving up enough money to make a twenty percent down payment is the most direct way to avoid private mortgage insurance, but a down payment of this size may not be feasible for some buyers, especially in markets where prices are on the rise. Here are some alternatives:

Piggybacking

A common alternative to PMI is to take out a second loan to pay back the twenty percent down in addition to the primary mortgage. This is known as piggybacking, which rearranges the loan into an 80/10/10 split, where the first loan accounts for 80 percent of the total property value, the “piggyback” or second loan covers the next ten percent, and the down payment covers the remaining ten percent. (There are other loan structures besides 80/10/10, this is just one example.) This can be an effective strategy for those who are ready to purchase a home but do not have the savings to make the full down payment. However, buyers should be aware that the second loan will likely come with higher interest rates.

VA Loans

VA Loans are a helpful resource for active service personnel and veterans looking to purchase a home. Not having to purchase mortgage insurance is included among the list of benefits VA Loans offer to qualified buyers, however, they require a one-time “funding fee” that functions similarly to mortgage insurance.

Lender-Paid Mortgage Insurance

LPMI may be a viable option for buyers in certain cases. Not to be confused by the name, LPMI is a restructuring of the loan in which the lender pays the mortgage insurance premium upfront. LPMI will remain in place for the life of the loan and usually comes with higher interest rates. Buyers should consider the terms of LPMI and how they differ from standard PMI to decide which is right for them.

Other

Other types of loans offer an alternative to conventional mortgages. FHA loans have their own mortgage insurance, as do USDA loans. The mortgage insurance premium (MIP) on FHA loans may be favorable, but buyers should keep in mind that in most cases they will be paying two different insurance premiums—the upfront rate and an annual fee. To be eligible for a USDA loan, there are several requirements that both the buyer and the property must meet.

To navigate the process of home financing and learn about the options around obtaining Private Mortgage Insurance, it helps to work closely with a great real estate agent who can help their clients identify lenders in their network that they know and trust to secure the right loan. For more information on purchasing a home, visit the buying section of our blog.