Avoiding PMI with Less Than 20 Percent Down

So you’re taking out a mortgage, but can’t put up a 20 percent down payment. Are there still ways you can avoid paying PMI?

PMI, of course, is private mortgage insurance. It’s the monthly premium you pay if you can’t put at least 20 percent down on a home purchase or have at least 20 percent equity in a refinance.

It doesn’t actually insure you, but compensates your lender in the event of default. The fees are usually equal to an annual charge of half to three-quarters of a percent of the amount borrowed, with the higher rates charged borrowers with weaker credit. At any rate, it makes sense to avoid paying it if at all possible.

The traditional route

The traditional way to avoid paying PMI on a mortgage is to take out a piggyback loan. In that event, if you can only put up 5 percent down for your mortgage, you take out a second “piggyback” mortgage for 15 percent of the loan balance, and combine them for your 20 percent down payment.

Unfortunately, piggyback loans of this type have pretty much disappeared since the collapse of the subprime mortgage market caused lenders to drastically tighten their credit standards. In fact, they’re considered one of the reasons the market collapsed in the first place, so it’s no wonder few lenders want anything to do with them these days.

Alternatives to piggyback loans

But you still have options for avoiding PMI. One is to borrow from other sources, such as relatives, in order to reach a 20 percent down payment. Unless they’re quite wealthy, you’ll have to pay them back, but you may be able to get better terms from them than you would from a private lender.

Another possibility is to have the lender pay the mortgage insurance. In a so-called “no-PMI loan,” the lender actually pays the PMI in return for charging a higher interest rate on the mortgage itself. This sometimes, but not always, can be cheaper than paying the PMI yourself.

If you and your spouse earn more than $100,000 a year, having the lender pay the PMI can be beneficial because the higher interest rates that result are tax-deductable. Actually, this is true for everyone, but starting in 2007, PMI became tax-deductable as well, but only for loans closed from that date forward and for households earning less than $100,000, so the tax-advantage for that group has vanished. The deduction is gradually phased out up to $110,000 annual income.

Consider VA, USDA mortgages

But the best option for avoiding PMI without putting 20 percent down is to take out a government-backed loan that doesn’t require it! Both VA and USDA Rural Development loans are available with little to no down payments without requiring PMI or other ongoing insurance payments. Both do require upfront fees – from 0.5 percent to 3.3 percent for VA loans and about 2 percent for USDA mortgages – but since these are onetime costs, they can be cheaper in the long run than paying PMI every month.

This is particularly true if you’re planning to stay in the home for a long time. It can also be advantageous in a declining or stagnant housing market where you’re not likely to be able to be able to gain a 20 percent equity stake simply through rising home value, which would allow you to cancel PMI.

There are limits on these types of loans, of course. VA mortgages are limited to veterans and USDA Rural Development loans cannot be used to purchase properties in urban areas – although they can be used in many adjoining suburban regions. USDA loans also have income limits, though are available to most middle-class buyers.

While FHA home loans technically do not require PMI, they do have an upfront charge of 2.25 percent of the amount borrowed, plus it’s own monthly mortgage insurance charge, which costs roughly the same as PMI. So no great benefit there from a PMI perspective.

One last thing about government loans. The interest rates may vary from what you might pay on a private sector mortgage, so it’s important to compare your options to find out what would make the most sense in your own situation.

There are pros and cons for both options, but there is no general approach. Each individual case merits its own research to discover the best outcome.