Are there mortgages with no PMI insurance on them?
Reader question: "From what I've read, a monthly mortgage payment is made up of five things. The principal, the property taxes, the homeowner's premium, the interest, and PMI insurance protection. Is there any way to avoid this last item? Are there mortgages with no PMI on them these days? Or do they all come with it?"
Yes, there are mortgage loans without PMI attached to them. Private mortgage insurance (PMI) is generally assigned to mortgages that have a loan-to-value (LTV) ratio above 20%. Stated differently, these policies are required whenever a single loan accounts for more than 80% of the purchase price.
If you make a down payment below 20%, and you're only using one mortgage to finance the property, there's a good chance you'll have to pay for PMI. This would increase the size of your monthly payments.
Here's an example. Let's assume I'm buying a house and I make a down payment equaling 5% of the property value. In this scenario, my home loan would account for the remaining 95% needed to purchase the property (95 + 5 = 100%). So the LTV ratio in this case would be 95%, well above the 80% threshold that usually triggers private mortgage insurance. So in this scenario, the loan would likely require a PMI policy. That's an additional cost for me, as the borrower.
Basically, mortgage insurance is a way to get around making a larger down payment. Without these policies, many home buyers would not be able to afford a loan, due to the large out-of-pocket expense. So in this respect, PMI makes homeownership possible to a larger pool of buyers, particularly those with limited funds.
Private Mortgage Insurance Protects the Lender, Not You
These policies protect the lender in the event that you stop making payments on your loan. The premium is added into your monthly mortgage payment, as you mentioned in your question.
The cost is borne by you, the borrower. That makes PMI a unique animal in the insurance world. In fact, it is one of the only forms of insurance where the person paying for the premium (the borrower) receives no protection whatsoever. Welcome to the wonderful world of mortgage lending.
Depending on the type of loan you are using, you might be able to cancel the PMI policy once you reach a lower LTV ratio, such as 80% or below. According to the Consumer Financial Protection Bureau (CFPB):
"The Homeowners Protection Act gives you the right to request that your lender cancel PMI ... when the principal balance of your mortgage is scheduled to fall to 80 percent of the original value of your home."
The rules are a bit different for FHA loans, however, so make sure you know what you're getting yourself into. Many FHA borrowers will actually have to pay the mortgage insurance premium for the life of the loan, due to a 2013 rule change.
Want a Mortgage With No PMI? Put More Money Down, or Piggyback
So, how do you get a mortgage with no PMI on it? There are two ways to accomplish this goal. You could make a down payment of at least 20%. You could also combine two loans in "piggyback" fashion. Here's what you should know about these two strategies:
1. Make a down payment of 20% or more.
If you put down 20% or more when buying a house, you will keep the loan-to-value ratio at or below 80%. So private mortgage insurance would not be required in this scenario. (Remember, an LTV of 80% or higher is typically what triggers the PMI requirement for borrowers.)
This is why a lot of borrowers strive to make a down payment of 20%, especially those who plan to stay in the home -- and keep the loan -- for a long period of time. Avoiding the added cost of a PMI premium could save you a lot of money over the long term.
Of course, this may not be an option for you, depending on your financial situation and the amount of money you need to borrow. If you can't come up with a 20% down payment, there is another way to get a mortgage with no PMI coverage...
2. Combine a first and second mortgage (piggybacking).
Piggyback loans are slowly making a comeback, after losing favor during the housing downturn. This is where the borrower uses two mortgages to cover the cost of a home purchase (or a significant portion of it).
The second mortgage is usually a home equity loan or line of credit. Both have an LTV ratio of 80% or below, which means they won't require PMI insurance. It's called piggybacking, because a second mortgage "piggybacks" on the first.
The 80-10-10 strategy is a common example. In this scenario, the first loan would account for 80% of the purchase price. The second would make up an additional 10%. And the borrower makes a down payment of 10% to complete the deal (80 + 10 + 10 = 100% of the purchase price).
So the bottom line is yes, there are mortgages without PMI added to them. You just have to keep the LTV for any individual loan below 80%. You can do that in one of two ways -- either by making a down payment of 20% or more, or by using the piggyback strategy described above.