How to Avoid Mortgage Insurance on Your Home Loan

Mortgage insurance is a policy that protects lenders from financial loss if a borrower defaults on their loan. It is required for home loans with less than a 20% down payment, representing increased risk for the lender. While protecting the lender, its cost is passed to the borrower, adding an extra monthly expense. This article explores ways borrowers can minimize or eliminate this cost.

Strategies to Avoid Mortgage Insurance at Loan Origination

Borrowers can take steps to prevent mortgage insurance when applying for a loan. A common strategy involves making a substantial down payment on a conventional loan. When a borrower contributes at least 20% of the home’s purchase price as a down payment, private mortgage insurance (PMI) is not required. This upfront investment reduces the loan amount, leading to lower monthly mortgage payments and often a more favorable interest rate over the life of the loan. A 20% down payment also provides immediate equity, offering financial flexibility.

Another option is Lender-Paid Mortgage Insurance (LPMI), where the lender covers the cost of the mortgage insurance premium. Instead of a separate monthly PMI charge, the lender compensates for this cost by charging a slightly higher interest rate on the mortgage loan. While LPMI eliminates a distinct monthly PMI payment, the increased interest rate means the borrower pays for the insurance through higher interest charges over the loan’s duration. A trade-off with LPMI is that it is not cancellable unless the mortgage is refinanced, meaning the higher interest rate remains for the life of the loan.

A “piggyback” loan (e.g., 80/10/10 or 80/15/5) offers another way to avoid mortgage insurance without a full 20% cash down payment. In an 80/10/10 scenario, a primary mortgage covers 80% of the home’s value, a second mortgage or home equity line of credit (HELOC) covers 10%, and the borrower provides a 10% cash down payment. This arrangement allows the borrower to achieve the 20% equity threshold on the primary loan, thereby avoiding PMI. Borrowers should be aware that this strategy involves managing two separate loan payments, and the interest rate on the second loan may differ from the primary mortgage.

Methods to Remove Mortgage Insurance After Your Loan Closes

For homeowners who currently pay mortgage insurance, there are established methods to eliminate this expense. One way is to formally request the cancellation of Private Mortgage Insurance (PMI) once sufficient equity has been built. Borrowers can request PMI cancellation on a conventional loan when the loan-to-value (LTV) ratio reaches 80% of the home’s original value. This request requires a good payment history, a written application to the loan servicer, and possibly a new appraisal to confirm the home’s current value, which the borrower pays for. Lenders may also require certification that there are no junior liens on the property.

The Homeowners Protection Act (HPA) of 1998 mandates the automatic termination of PMI under specific conditions for loans originated after July 29, 1999. Under the HPA, PMI automatically terminates when the mortgage’s principal balance is scheduled to reach 78% of the home’s original value. Automatic termination also occurs by the midpoint of the loan’s amortization schedule, provided the borrower is current on payments. If the borrower is not current, termination occurs on the first day of the month after payments become current.

Refinancing the existing mortgage offers another path to removing mortgage insurance. If the new loan’s LTV is 80% or less, the borrower may qualify for a new conventional loan without PMI. This strategy can be appealing if current interest rates are lower than the existing loan’s rate, potentially leading to overall monthly savings. However, refinancing involves closing costs and fees, which can range from 2% to 5% of the loan amount, and these costs should be weighed against the savings from eliminating mortgage insurance.

Specific Loan Programs Without Mortgage Insurance

Certain government-backed loan programs do not require traditional monthly mortgage insurance, making them attractive options for eligible borrowers. VA loans, guaranteed by the U.S. Department of Veterans Affairs, are available to qualifying service members, veterans, and their surviving spouses. A benefit of VA loans is that they do not require a down payment and do not have a monthly mortgage insurance premium. While there is no monthly mortgage insurance, VA loans do include a one-time VA funding fee, which can be financed into the loan or paid upfront, and serves a different purpose than ongoing mortgage insurance.

USDA loans, backed by the U.S. Department of Agriculture, are designed for low-to-moderate-income borrowers purchasing homes in eligible rural and some suburban areas. These loans require no down payment and do not feature a traditional monthly mortgage insurance payment. However, USDA loans do have an upfront guarantee fee, around 1% of the loan amount, and an annual fee, about 0.35% of the outstanding principal balance. These fees, while structured differently from conventional PMI or FHA Mortgage Insurance Premiums (MIP), contribute to the program’s sustainability. In contrast, FHA loans, another government-backed option, consistently require both an upfront MIP and an annual MIP, meaning they are not a pathway to avoiding mortgage insurance.