Mortgage Advice

How to Avoid Paying Private Mortgage Insurance (PMI)

November 28, 2012

When it comes to buying a home, there are a lot of unavoidable expenses, like inspection fees, down payments and closing costs, just to name a few. If you’ve grown financially weary, I’ve got good news. While not every cost associated with buying a home can be avoided, there is one that can: private mortgage insurance (PMI).

What is PMI? Just like property insurance protects homeowners against damage done to their home, private mortgage insurance protects lenders from the risk of borrowers defaulting on a loan. To do this, lenders are required to add the cost of PMI into your monthly mortgage payment.

Conventional wisdom says you should have at least 20% to put down on a house. Why? Not only does it reduce the amount of risk being assumed by the lender, it also lowers your monthly mortgage payment and interest rate and allows you to avoid paying PMI.

When homebuyers cannot purchase a home with at least 20% down, lenders will apply PMI to the mortgage to minimize the additional risk they are assuming. If you cannot afford to put 20% down on a house, don’t worry. There are still other ways you can avoid paying PMI.

Loan-to-Value Ratio (LTV)

One way for current homeowners to get rid of PMI is to have a loan-to-value ratio of at least 80%, or in other words, achieve 20% equity. LTV is the difference between the amount of your loan and the value of your home.

To calculate your home’s LTV, simply divide your loan amount by the value of your home. For example, if you borrowed $180,000 for a home valued at $155,000, your LTV would be .86 or 86%. Once your LTV reaches 80%, you are no longer required to pay PMI.

There are a few ways you can decrease your LTV and increase equity in your home. As you continue to make your monthly mortgage payments, the LTV ratio will continue to drop. To accelerate the process, you can make extra payments each month.

Increasing the value of your home will also lower your LTV ratio. This can be achieved through home improvement projects or rising home values in your area due to an improved housing market. Consider having someone appraise your home to obtain the exact value.

Lender Paid Mortgage Insurance (LPMI)

If you have less than 20% equity, lender paid mortgage insurance (LPMI) is hands down the way to go. It’s the easiest way to dodge expensive PMI payments, and it’s accessible to both homebuyers and current homeowners.

Essentially what happens is in return for a small increase to your interest rate, the lender pays your mortgage insurance for you. The only requirement is you must have at least 95% LTV or 5% equity.

Even though you may be incurring a slightly higher interest rate, you’re setting yourself up to save more money over the life of your loan. And, just like with regular PMI, as soon as you reach 20% equity in your home, you’ll have the option of refinancing into a regular 80% LTV mortgage loan.

Don’t be intimidated by the number of expenses that come with buying a new home. With historic low rates and plenty of incentives like LPMI being offered to homeowners, now really is the perfect time to buy a home and/or refinance your existing mortgage.

Questions? Leave a comment, or give me a call at 248.658.2561. 

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