How buyers can avoid PMI
Private mortgage insurance (PMI) is the bane of the low-downpayment homebuyer (a group that often includes first-timers). It rears its onerous head when a buyer offers less than 20 percent as down payment for a conventional home loan.
When a buyer borrows with a loan-tovalue (LTV) ratio of less than 80 percent, the bank requires private mortgage insurance to offset the risk of default.
“PMI is really a bad word in my vocabulary,” says Peter Holmes, senior loan officer at Sterling Mortgage in Alameda. “I think that PMI is something that should be avoided whenever possible.”
“Avoiding PMI is a great idea,” agrees Tuan Vo, managing senior
broker at Providential Mortgage in Fremont. “It’s basically kind of a waste of money.”
Private mortgage insurance can amount to 0.3 percent to nearly 1.5 percent of the loan amount per year. In a market where home prices typically start in the upper six figures, the pesky premium can add thousands per year to the cost of your mortgage. And if you elect to pay for the insurance upfront, and you sell the home before the LTV ratio reaches 80 percent you
won’t be able to get the PMI payment back.
The tax bill signed into law in December makes PMI even more burdensome.
“Private mortgage insurance used to be tax-deductible,” Holmes advises. “Through the new tax bill, (it) is going to be non-tax-deductible.”
Even if you cannot put down 20 percent, there are ways to avoid PMI. Many area lenders offer no-PMI loans. Typically, this means the bank will pay the insurance for you. There is a downside, however.
“The trade-off is … that the buyer typically will have to accept higher
interest rates, usually about 1 percent higher than what they would ordinarily get, for as little as 5 percent down on up to $1.5 million,” Holmes states.
And it’s not a cakewalk. “Buyers have to be able to, obviously, qualify in a fully documented manner,” Holmes warns.
On the other hand, the higher interest rate doesn’t have to be a life sentence.
“What I see a lot of our buyers doing is getting into these low-downpayment, no-PMI loans, and then letting the equity appreciate in their new home purchase … then coming back to us and refinancing … a year
later into a non-PMI interest rate.”
Relying on an increase in the value of your home may not be wise, however.
“There’s always a risk in that,” Vo advises. Clients “get into a house, and they’re hoping the equity will go up … that home values will rise so quickly that by the end of the year, they will have 20 percent equity, and they can basically refinance out of it. … But you never know. What if the home values don’t continue to go up?”
A slightly more convoluted way of avoiding PMI is to take out a first and a second mortgage loan at the time of
purchase. The practice is known as “piggybacking.” The concept is to achieve the bank’s 80 percent loan-to-value ideal using two loans instead of one.
For example, if you elect to put down 10 percent of your own money, you can take out one mortgage loan for 80 percent of the cost of the property and a second mortgage to cover the other 10 percent. There is a downside to this strategy as well.
“Most of the time, the second loan (interest) rate is a lot higher,” Vo explains. “So it just depends on the scenario.”
Your best bet is to perform a thorough analysis of every available PMI and
non-PMI option before settling on an approach. According to the Consumer Financial Protection Bureau, the higher interest rates involved with avoiding PMI can end up costing you more than paying PMI. (If you take out an FHA loan, there is no way to avoid PMI. A VA loan requires neither a down payment nor PMI.)
Loan interest rates, private mortgage insurance rates and the likelihood of your home’s appreciation are among key factors in deciding which course to take. Reviewing your analyses with your financial adviser is also a good strategy.