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TMI about PMI: Get mortgage smart before you buy

By: Movement Staff
June 14, 2016

Nod your head if you agree: Mortgage terms make your head hurt.

They're not fun words.

And unless your idea of a good time is flipping through "Mortgages for Dummies" (we really hope it's not), it's unlikely phrases such as "paying my PMI" or "taking out a piggyback loan" enter your everyday conversation.

Yet, they're pretty important if you want to understand mortgages and, you know, buy a house.

Here, we explain PMI, an acronym you'll likely encounter if you're on the market for a new house. After this, you'll feel 10 times more confident about home buying…or, you'll at least be the smartest person at the dinner table.

OK, what's PMI?

Glad you asked. PMI is an acronym for "private mortgage insurance." It's generally something you pay each month if you put down less than 20 percent on your home. In short, PMI is a premium you pay to an insurance company to guarantee that the lender gets its money back if you default on your loan.

PMI is typically added to your monthly mortgage payment, which can translate to — brace yourself — hundreds (or even thousands) of dollars per year in loan costs (yuck, we know).

There is some good news: On most conventional mortgages, you can request PMI be removed once the principal balance of your mortgage is reduced to 80 percent of the original value of your home.

Just make sure you're up-to-date on your monthly payments and don't have any other liens — like a second mortgage — floating out there, according to the federal Consumer Financial Protection Bureau.

The not-so-great news: Paying down your principal takes time — years. You may have to make your PMI cancellation request in writing. And there's a chance your lender will require you to have the property appraised at your expense because…why would it be easy?

Also, keep in mind that some programs, such as FHA mortgages, carry Mortgage Insurance Premiums (MIP), to the bitter end. This is similar to PMI and adds to the cost of your mortgage.

Can I get around it?

Sure you can. Here's how:

  • VA loans: If you've served in the military, you may be eligible for a Veterans Affairs loan, which doesn't require any mortgage insurance. 
  • USDA loans: These loans, supported by the U.S. Department of Agriculture, finance home purchases for low- and moderate-income families living in rural areas. And they don't have PMI. Instead, borrowers pay an upfront insurance premium that covers any losses if the borrower defaults on the loan. This fee can be wrapped into your mortgage and may be much smaller than traditional PMI.
  • LPMI: We know, we know, another strange acronym. This stands for lender-paid mortgage insurance, and that's exactly how it works: Your lender pays your insurance premium upfront in a lump sum, so no PMI.

The drawback: You have to pay the lender back. How? Usually, in higher interest rates on your mortgage loan.

  • Piggyback loans: These loans are basically second mortgages borrowers use to make up the difference if they can't put down 20 percent on their home, but still want to avoid PMI.

For example, you take out a first mortgage for 80 percent of your home's value. You simultaneously take out a 10 percent piggyback loan and then scrounge up enough cash to cover a 10 percent down payment on your home. You combine the piggyback loan with your down payment and BAM! Your lender deems it a 20 percent down payment and you've evaded the dreaded PMI.

Time to celebrate, right? Well…

Here's the downside: You'll be making two loan payments each month (double yuck) and, unlike PMI, you can't cancel a piggyback loan — you have to pay it off completely (bummer).

Your best bet?

Find a mortgage professional who can look at your unique situation and tailor a mortgage that's right for you. Ask lots of questions. Know before you owe.

Author: Movement Staff

The Market Update is a weekly commentary compiled by a group of Movement Mortgage capital markets analysts with decades of combined expertise in the financial field. Movement's staff helps take complicated economic topics and turn them into a useful, easy to understand analysis to help you make the best decisions for your financial future.