If you’re looking at buying a home, there are three little letters you’ll probably hear a lot about in the process: PMI.
PMI is private mortgage insurance, which lenders use when borrowers request a loan but look risky due to their low down payment. It’s a big benefit to lenders, because that insurance provides some reimbursement for defaulted loans.
The policy pays out to the lender should a borrower fail to repay their balance. And while PMI enables you to buy a home with less than 20% down, it also adds to your cost: that monthly insurance premium is your responsibility to pay, even though it’s for the benefit of the lender.
But it is possible for prospective home buyers to avoid PMI, even with a less-than-20% down payment. Low down payment programs, piggyback loans, home investment plans, and other options give prospective homeowners a few different paths to explore.
Here are the pros and cons of each of these alternatives for a “no PMI” mortgage loan, and what you need to know before choosing one for you.
Federal Low Down Payment Mortgage Programs
The Federal Housing Administration (FHA) insures loans for low-credit borrowers and those with low down payments. With FHA backing, lenders are free to approve riskier loans — which provides more opportunities for homeowners to buy even with very small down payments.
Here are some of the benefits:
- Requires only 3.5% down
- Reasonable interest rates (dependent upon credit, income level, debt, etc.)
- Low closing costs vs. conventional loans
- Consumer avoids PMI
- No set income limit
- Borrower can use gifted money for down payment
However, FHA loans don’t provide a perfect solution. While you’ll avoid the PMI that comes with a conventional loan, there are different types of fees that come with these mortgages.
Here’s what you need to know about those additional costs:
- Mortgage Insurance Premium (MIP) fee added at closing
- Monthly MIP fees for the life of the loan or 11 years (with 10% or more down)
- MIP rates have been reduced for 2017
- MIP costs may exceed PMI when considering upfront fees and monthly premiums
Depending on your situation, a conventional loan — even with PMI — might make more financial sense than an FHA loan.
No PMI with a VA Loan
Another option that would allow you to avoid PMI with a low down payment (or even no down payment) is a loan backed by the U.S. Department of Veteran’s Affairs (VA loan). For qualifying service members, spouses, and veterans, this can be an outstanding choice for financing.
VA loan requirements may differ from the lender who carries the loan. Getting the best VA loan will require you to shop around and do your research on individual lenders — but that effort is well worth it for the benefits, which include:
- No down payment required (unless required by individual lender)
- No minimum credit score required by VA (lender may have guidelines)
- No mortgage insurance payments
- Closing costs capped by VA
- Competitive interest rates
Keep in mind that you’ll need Certificate of Eligibility (COE) from the VA before applying. And you’ll want to be aware of the downsides here, too:
- VA funding fee (generally around 2.15% of the loan) which can be spread among monthly payments
- Property must meet the standards of VA appraisal process
- Buyer must have residual income (proof of income left after paying all living expenses)
No PMI with a Piggyback Loan
An 80-10-10 loan, which is also known as a piggyback loan, is a fancy term for a bit of creative financing. Prospective homebuyers take out a conventional mortgage loan — and a second loan that covers half of the total down payment.
This loan works for buyers who only have a 10% down payment and want to avoid PMI insurance. The larger loan covers 80% of the home’s purchase price and requires a 10% down payment or more.
The smaller 10% loan makes up the difference of the required 20% down payment to avoid PMI, one of the biggest benefits of using this strategy. Others include:
- Requires only 10% down payment
- Many lenders offer this financing, giving borrowers lots of options for shopping around
- Can result in a lower mortgage payment compared to FHA or conventional with PMI (dependent on various factors)
However, piggyback loans can be much more expensive in some cases. A mortgage calculator can help determine if a piggyback is cheaper than one loan with PMI, since the second loan debt you need to repay (with interest). That’s one downside, but there are others you need to watch out for as well:
- Must have good credit
- Must qualify for two loans — often from different lenders
- Second mortgage often has an adjustable interest rate
- Two sets of closing costs
- Must make higher payment on second mortgage (often requires only monthly interest payment) to pay it off
Down Payment Assistance Programs
Most prospective home buyers have no idea that they may be eligible for down payment assistance. Through the U.S. Department of Housing and Urban Development (HUD), most states have a fund that is allocated for helping low- to mid-income families buy homes of their own.
These funds are qualified for and dispersed at the local level in the form of grant money that doesn’t need to be repaid. There is assistance for down payments, individuals with disabilities, and help with closing costs among others.
Here’s what to think about before looking into HUD programs:
- Must meet income limits to qualify
- Credit score requirements vary
- Often requires homeowner education/counseling
- Buyers often must put some money down (requirements vary by state)
- Must show income sufficient to cover expenses
- Often for first-time home buyers (or 3 years since ownership)
- Home may have specific location requirements to qualify
Home Ownership Investment Programs
Many of these options for avoiding PMI on a mortgage loan may not apply to you — or they may not provide a cheaper alternative to what you’ll pay with private mortgage insurance. In this case, there’s still one option to consider: home ownership investment programs.
Programs like Unison HomeBuyer allow you to double your 10% down payment into a full 20% down payment so you can access conventional mortgage loans without paying PMI.
That money is an investment, which means you don’t have to make monthly payments to Unison. Instead, Unison receives a share of any future change in the value of your home when you sell it – up to 30 years later.
This allows you to buy the home you want without PMI – while maintaining financial flexibility and avoiding larger monthly payments.
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