Can You Avoid PMI With a 10% Down Payment?

Understanding Standard PMI Requirements

Private Mortgage Insurance (PMI) serves as a financial safeguard for lenders. Its primary purpose is to mitigate the risk lenders face when borrowers default on their mortgage loans. This insurance becomes a requirement when a homebuyer makes a down payment of less than 20% of the home’s purchase price, adding an additional charge to the monthly mortgage payment.

The requirement for PMI is directly linked to the loan-to-value (LTV) ratio of a mortgage. Lenders assess loans with an LTV above 80% as carrying a higher risk of default. The LTV ratio is calculated by dividing the loan amount by the home’s appraised value or purchase price, whichever is lower.

PMI payments are structured as a monthly premium added to the regular mortgage payment. This ongoing cost continues until a sufficient amount of equity is built in the home, or specific conditions are met for its removal. The amount of PMI can vary based on factors such as the loan amount, the LTV ratio, and the borrower’s credit score.

Strategies to Avoid PMI with Less Than 20% Down

While a 20% down payment is the traditional threshold to avoid Private Mortgage Insurance (PMI), several strategies can allow homebuyers to bypass this expense even with a smaller initial investment, such as a 10% down payment. These alternative approaches involve different loan structures or specific government-backed programs designed to address various financial situations.

One method is through Lender-Paid Mortgage Insurance (LPMI). Here, the lender pays the PMI premium on behalf of the borrower. To compensate, the lender charges a slightly higher interest rate on the mortgage loan. The increased interest rate means higher monthly payments and a greater total cost of interest over the loan’s life.

Another strategy involves a “piggyback loan.” This arrangement includes a first mortgage covering 80% of the home’s value, a second mortgage or home equity line of credit (HELOC) covering 10%, and the remaining 10% as the borrower’s down payment. The second loan will have its own interest rate and repayment terms, which can sometimes be higher than the first mortgage rate.

VA loans, backed by the U.S. Department of Veterans Affairs, do not require PMI, even for borrowers making no down payment. These loans are available to eligible veterans, service members, and surviving spouses. While a funding fee is associated with VA loans, it serves a different purpose than PMI and can sometimes be financed into the loan or waived for certain disability ratings.

USDA loans, offered through the U.S. Department of Agriculture, are available for homebuyers in eligible rural and suburban areas. These loans do not require traditional PMI. Instead, USDA loans include an upfront guarantee fee and an annual guarantee fee, which are lower than conventional PMI premiums.

FHA loans, backed by the Federal Housing Administration, require Mortgage Insurance Premiums (MIP) instead of PMI. With a 10% down payment or more, the MIP requirement may terminate after 11 years. However, MIP cannot be cancelled based on reaching a certain equity percentage, as is often the case with conventional PMI. This can make FHA loans more expensive over a long term of homeownership.

Financial Implications of PMI Avoidance Strategies

Considering the financial trade-offs of PMI avoidance strategies is important, as each option carries distinct cost implications. While these methods can help bypass monthly PMI payments, they often introduce other expenses or higher overall costs that warrant careful evaluation.

Lender-Paid Mortgage Insurance (LPMI), while eliminating a separate monthly PMI premium, results in a higher interest rate on the primary mortgage. This increased interest rate translates to higher monthly principal and interest payments over the entire loan term. Borrowers should compare the total cost difference between a lower interest rate with PMI versus a higher interest rate with LPMI to determine the most cost-effective option.

Piggyback loans involve managing two separate loan payments. The second mortgage or Home Equity Line of Credit (HELOC) carries a higher interest rate than the primary mortgage, and it may have a variable rate, leading to fluctuating payments. Closing costs are incurred for both the first and second mortgages, increasing upfront expenses. While avoiding PMI, the combined interest payments and potential for variable rates on the second loan can result in a higher total cost of borrowing compared to a conventional loan with PMI.

VA and USDA loans avoid traditional PMI but come with their own associated fees. VA loans include a funding fee, which ranges from approximately 1.25% to 3.6% of the loan amount. This fee can be financed into the loan, increasing the overall loan balance. USDA loans have both an upfront guarantee fee, 1% of the loan amount, and an annual guarantee fee, around 0.35% of the outstanding principal balance. These fees are lower than conventional PMI over the loan’s life, but still represent an additional cost.

FHA loans require Mortgage Insurance Premiums (MIP). Unlike conventional PMI, FHA MIP is required for the entire loan term if the initial down payment is less than 10%. If the down payment is 10% or more, the MIP can be cancelled after 11 years. This extended duration of MIP can make FHA loans more expensive over the long term. Borrowers planning to stay in their home for an extended period should carefully consider the total cost of FHA MIP versus conventional PMI.

Removing PMI After Your Loan Closes

Even if Private Mortgage Insurance (PMI) is initially required, pathways exist to remove it after the mortgage loan has closed. The Homeowners Protection Act (HPA) of 1998 dictates conditions for automatic termination or requested cancellation of PMI.

Automatic termination of PMI occurs when the loan-to-value (LTV) ratio reaches 78% of the original home value. This happens automatically on the date the mortgage balance is scheduled to reach 78% LTV. The lender is required to notify the borrower annually of this right and the date on which PMI is scheduled to terminate.

Borrowers also have the right to request PMI cancellation once their LTV ratio reaches 80% of the original loan amount. To initiate a borrower-requested cancellation, specific requirements must be met. The borrower needs to have a good payment history. Additionally, the property must not have any junior liens, and the lender may require a current appraisal to confirm the home’s value.

Building equity faster can accelerate the removal of PMI. Making extra principal payments on the mortgage can help the loan balance decrease more quickly, allowing the LTV ratio to reach the 80% or 78% thresholds sooner. Home improvements that significantly increase the property’s value can also contribute to building equity, potentially allowing for an earlier appraisal-based cancellation request.

Refinancing the mortgage is another strategy to eliminate PMI if the home’s value has increased substantially or if the borrower can now make a 20% down payment on the new loan. A new loan, based on the current higher appraised value, might result in an LTV of 80% or less, thereby avoiding PMI on the refinanced mortgage. This option should be evaluated in light of new closing costs and interest rates associated with a refinance.