Private mortgage insurance (PMI) is applied to conventional loans in order to protect lenders. Normally, when borrowers try to purchases a house, lender will require a down payment that costs 20% of the total purchase price. However, for some people, down payment is a huge amount of money and they cannot afford it. At this moment, lenders will require borrowers to purchases private mortgage insurance to avoid default and it they do default on payment, they will face foreclosure.
How does it work?
Lenders will use loan-to-value (LTV) ratio and down payment to evaluate the mortgage. If the mortgage’ LTV ratio is greater than 80% or the borrowers cannot afford down payment, lenders will consider this mortgage as a risky investment thus they would urge the borrowers to purchase private mortgage insurance.
PMI is usually paid within monthly payment or it can be paid as premium when the loan closes. PMI normally costs 0.5% or 1% of the total loan each year, but this cost is not permanent. Borrowers can ask lender to remove their PMI when they have paid back the major amount of the loan which should reach 20% of the down payment.
Although it is necessary for borrowers, particularly first-time borrowers, to purchase PMI if they wish to buy a house, it is rather expensive. To avoid PMI, there are two major measures.
For those who wish to avoid down payment, some of them suffer from low income and cannot afford it. In this case, they can use piggybacking. They can take out another loan, generally a smaller one, to cover the amount of down payment. When they fill out their tax return, they can deduct the interest on both loans.
- Reconsidering your purchase
If potential buyers cannot afford the 20% down payment and they do not wish to use piggybacking, it is time for them to think twice about their purchase and they may choose another one that is within their budget.