There are many intricacies within the home buying process, yet it seems that most are related to obtaining the right home loan. Many first time buyers have a preconceived notion that a 20% down payment is required for a home loan, which is not true. You can, in fact, obtain a home loan with less than a 20% down payment, which typically would have mortgage insurance. However, there are a couple of ways to avoid mortgage insurance when you put less than 20% down.
What is Private Mortgage Insurance?
PMI is used as added security for the mortgage lender with conventional or FHA loans. When putting less than 20% down on a home, the mortgage lender is essentially taking on more risk and wants more assurance that they are covered. PMI comes in the form of an added monthly expense for the home buyer and is added into the monthly mortgage. Your PMI is calculated based upon your credit score, your loan terms, loan type and how much you put down; typically, the less you put down, the higher the PMI. To see the relationship between LTV and your credit score when calculating PMI, refer to this chart.
Can PMI Be Avoided With Less Than 20% Down?
To avoid PMI, many home buyers feel that they have to put at least 20% down on a home. It’s true that putting 20% down avoids PMI, yet there are other ways to accomplish this with less than 20% down. Here are three additional ways that a home buyer can avoid Private Mortgage Insurance:
Lender Paid Mortgage Insurance (LPMI)
Lender Paid Mortgage Insurance is simply having a slightly higher interest rate versus monthly PMI. The total monthly payment with LPMI is virtually always less than the total monthly payment associated with Borrower Paid Mortgage Insurance (BPMI). The advantages of LPMI are that the payment is lower and the interest is tax deductible (please note that mortgage insurance is tax deductible only up to an income of $109,000)*. The downside is that LPMI is built into the rate and will remain the payment for the life of the loan. It’s important to look closely at the numbers to see what would ultimately be best for your own scenario. Typically, higher income earners go with LPMI or the 80/10/10 option discussed below. *Please meet with your tax consultant for more information on tax deductible mortgage insurance, listed above are the general standards that are set by the IRS. We are not tax advisors.
Often referred to as “piggyback financing”, the buyer takes two mortgages that are “piggybacked” onto one another. The most common loan arrangement using this option is called an 80/10/10; an 80% first mortgage, a 10% second mortgage, and a 10% down payment. What do these numbers mean? Well, the first 80% refers to what percentage of the home’s value the primary mortgage will lend. This has to be less than or equal to 80% to avoid PMI. Then, the second 10% represents the percentage of the home’s purchase price that the second mortgage will lend. This will generally carry a slightly higher interest rate than the primary 80% mortgage.** Finally, the 10% down payment is the amount you are putting down for the home. It doesn’t necessarily have to be 10%, but this is the most common.
An added benefit of an 80/10/10 is that if your first 80% loan is within the conforming loan limit instead of a high balance loan limit, you’ll save extra money on the interest rate in addition to avoiding mortgage insurance. For example, a $500,000 purchase with 10% down will be a $450,000 loan amount which is greater than the current $417,000 maximum conforming loan limit and a Jumbo or High Balance loan has a higher interest rate. However, an 80-10-10 will have the 1st loan be $400,000 (under the conforming limit) and a second of $50,000. A professional mortgage broker/banker can optimize the best scenario for your loan.
If you are interested in seeing more examples of 80/10/10 loans, MI, and LPMI please click here.
**Inspira Group, as of January 2016, has an amazing fixed-rate second loan which is superior to virtually all of the other second loans, which are typically adjustable rate. The rate is fixed and can match the low 4's where rates are currently trading.
Finally, qualifying home buyers can utilize a VA (Veterans) loan. VA loans do not charge PMI regardless of loan-to-value (LTV) ratio.
Though PMI often go hand-in-hand with a less than 20% down payment on a conventional or FHA loan, home buyers should know that this doesn’t always have to be the case. There are ways to avoid mortgage insurance, such as Lender Paid Mortgage Insurance, 80/10/10 financing options, and VA loans. An experienced professional mortgage broker/banker will know the different options to consider and will find the best loan option for you. Understanding the intricacies of the home buying and home loan process can be made easy when you have the right real estate team by your side finding the right loan for you and helping you follow your dreams of owning a home!