Avoid PMI and Save Money

The size of your down payment and your credit history decide how much you pay in PMI (Private Mortgage Insurance. Let's look at what you can do to minimize its cost to you.


This page:

  • Explains the relationship between down payment and PMI

  • Explains how PMI can be avoided or minimized

  • Helps you decide whether avoiding PMI is feasible for you

In the following pages we describe the elements of the mortgage package. The second section of the guide examines your credit capacity and how lenders look at the mortgage collateral.

Refer to the table of contents if you're looking for specific information.

What decides the cost of PMI?

No matter what size your down payment, the traditional 20% figure is still important today when it comes to private mortgage insurance (or PMI). (If you're unfamiliar with PMI, read about it in our mortgage basics guide.)

Most lenders require that you pay for this insurance (which is for their protection, not yours) until the LTV (loan-to-value ratio) on your mortgage drops below 80%. But there are ways to minimize the cost.

PMI usually costs about ½% of your total loan amount per year. This can add thousands of dollars to your annual financing costs. But the real trouble with PMI is that it's based on home equity (the "amount" of your house that you actually own).

So at the beginning the mortgage's life, when most of your monthly payments go toward interest, only a fraction of the money is going into equity (and towards getting rid of pesky PMI).

The upshot of this is that, without a sizeable down payment, you may end up paying PMI for longer than you had anticipated, and at a greater cost. And you're not even paying for your own protection.

(Note: Lenders are required to tell you for how many months you'll need to buy PMI under a certain mortgage program so make sure you find out up front.)

How to avoid (or at least minimize) the cost of PMI

Paying PMI is always a drag, but in some situations you feel the pain a lot less. Here's our list:

  • If interest rates are low and you think they'll increase soon, you may not want to waste time saving more money for a down payment. Catch a great rate now (especially on a FRM) and you may actually save money even with the cost of PMI if rates end up soaring later.

(This is especially true if you own your home for a while. Then a low-rate FRM really pays off and the expense of PMI for the first years of the mortgage won't seem so great.)

  • If you're financing with an ARM and plan on moving again soon, paying PMI now can pay off when you purchase again. You can take advantage of the artificially low initial rate on your ARM to build home equity quickly and cheaply. When you sell and buy again, that equity can help allow you to increase the size of your next down payment.

  • Likewise, if you think you finance with an ARM, and interest rates fall or your salary rises considerably in the future, the cost of PMI will probably be offset by the initial rate savings.

  • And if you're a subprime borrower, avoiding PMI may not be a huge concern. Some lenders won't require it. Others require it until you reach a particular higher level of equity in your home. Either way, you'll be paying mortgage insurance - it might just be in the form of a higher interest rate. (After all, a high rate is simply a lender's "insurance" to itself for taking on a greater credit risk.)

FullSpectrum Lending includes all PMI in your interest rate, which is great, because interest is tax deductible, allowing you to save the entire cost of private mortgage insurance. If your credit is so-so, get pre-approved at FullSpectrum today.

  • Tax-deductibility is also a big draw of the PMI- free zero-money-down mortgage increasingly offered by lenders today. These loans carry LTV ratios of up to 110%, and while their interest rates are higher, they're not nearly as high as those on subprime mortgages. And, once again, you'll reap the tax rewards of deductible interest charges. (Eloan offers a line of flexible zero-money-down mortgages at very reasonable rates.)

The bottom line on PMI

Avoiding PMI is one of the best reasons for a prime mortgage buyer to put as much money into the down payment as possible. The long-term savings can easily outstrip the immediate increased expense.

There are situations (like our list above), where the expense can be justified. But it's probably wise to avoid PMI altogether whenever possible.



Next: The last part of your mortgage package: closing costs

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