Borrowers with conventional loans — those that are not government-backed — and can’t or don’t want to pay a down payment of 20% pay PMI or private mortgage insurance. This will be communicated to you by your mortgage broker if your LTV or loan-to-value ratio is higher than 80%. Much like other insurance forms, there is a premium for private mortgage insurance that is usually bundled with the monthly interest rate, in addition to the homeowner’s insurance. Altius Mortgage Group shares more information below:
What Exactly Does Private Mortgage Insurance Cover?
In simplest terms, it has to do with protection and risk since a mortgage without or little down payment is more inclined to default than a mortgage with a higher down payment. In addition, even if the borrower with a high down payment fails to repay, lenders may still be able to sell the property and keep the profits regardless of foreclosure.
In the case of a loan with no down payment and home prices fall, it can become an underwater mortgage, which means a loss for the mortgage lender when they try to offset it. Once you default on a mortgage with mortgage insurance, your lender will get compensation from the insurance company for covering all losses associated with your loan. In short, you pay for PMI not for yourself, but for your lender.
Can I Avoid Private Mortgage Insurance?
If you really don’t want to pay for private mortgage insurance, with “no money down,” you can choose to take a combo loan instead. There are also loan programs that don’t require you to pay mortgage insurance if your loan-to-value ratio is higher than 80%. But, the PMI is actually already factored into your mortgage rate, so you are still indirectly paying for it. You can also choose to cancel your PMI, but this will take a while and requirements are strict.
The majority of homeowners today choose to just get a second mortgage rather than having one to avoid higher rates and PMI. But, a second mortgage will also come with its set of fees and monthly payment. In any case, just do your homework regarding having two mortgages to see if it can be a more economical alternative.