Avoiding PMI – It Can Be Done!

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privatemortgageinsurance

pmiUnless you’ve been living under a rock for the past few years, you know that home-buyers today are fortunate to have the opportunity to be able to take advantage of historically low mortgage interest rates. After the onset of the recession in 2008, rates on home loans dipped to around 4%, and in the past year have dropped even lower. To put this in perspective, when my parents bought their first house in 1982, they paid 16.5% interest on their mortgage. Oh how times have changed!

But many would-be buyers face a conundrum: they have good credit and want to take advantage of rock-bottom rates, but they don’t have enough saved to provide the traditional 20% down-payment on their first place. And 20% down is key, because this is the magic number that allows homeowners to avoid the dreaded private mortgage insurance (PMI).

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So what is PMI anyway? Basically, it’s an insurance policy that lenders will force you to take out to protect them in the case that you default on your mortgage. If you’re only putting, say, 5% down on your mortgage, that basically means that the bank you’re borrowing the money from is taking on 95% of the risk of the loan. Most banks are uncomfortable with this and will require you to purchase PMI to protect them in the event that you don’t pay on your mortgage. PMI can add a substantial sum to your monthly costs, usually a few hundred dollars. This is why putting down 20% is ideal, because in this case the bank is only taking on 80% of the risk and most won’t require you to purchase extra insurance.

The good news, though, is that there are options for avoiding PMI even if you can’t put down twenty percent. With as little as 5%, you may be able to avoid this money pit and get into the home of your dreams while interest rates are still at rock bottom. Consider:

Looking into special programs

In order to create some good karma within the areas they serve, many banks offer special, first-time home-buyer programs in specific neighborhoods. Often referred to as “community” mortgage programs, they frequently allow for low down-payments and waive PMI for those with good credit. When you begin looking for a mortgage, be sure to ask potential lenders about these opportunities.

“Buying out” your PMI with a slightly higher interest rate

In an effort to attract credit-worthy customers who lack the cash to put down 20% but also don’t want to pay PMI, many large banks offer the option to “buy out” the PMI on a mortgage in exchange for a slightly higher interest rate. Usually, the rate bump is around half a percentage point, meaning that the borrower pays about .5% more on his mortgage than he otherwise might in exchange for dodging PMI. In most cases this makes much more sense than paying PMI, which would cause a significantly higher monthly payment than a minor interest rate increase.

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Credit unions

Due to their non-profit nature, credit unions often offer cost-reducing options on mortgages that traditional banks don’t, including waiving PMI for customers with good credit. Be sure to shop around when you’re looking for a mortgage and keep credit unions on your radar – you might be surprised at the money you could save by going with a slightly less conventional route.

Avoiding PMI is possible, so don’t believe the hype that 20% down is an absolute “must” when obtaining your first mortgage. Remember: everything’s negotiable, so don’t be afraid to ask for options to avoid paying more than you absolutely must!