What is PMI and How to Avoid It
The most common way of financing a real estate investment of the magnitude of a Park Grove Miami home is usually through a mortgage. A mortgage is a long-term loan acquired from a lending institution for the purposes of purchasing a home.
Then lending institution is in the mortgage business to make a profit. When they provide you with the financing that enables you to acquire your Park Grove Miami home, they have to take measures that increase the odds of getting a return on their investment.
One of the biggest risks to their investment is if the borrower defaults on the mortgage. So after evaluating the financial position of the borrower, the lender can reduce their risk exposure to default or foreclosure by insisting on insurance coverage on the mortgage. This insurance coverage is what is called PMI, Private Mortgage Insurance and its purpose is to protect the lender from default and foreclosure.
So as you plan on purchasing your Park Grove Miami home, you might be asking yourself, how can I avoid paying private mortgage insurance? How do I look like a lower risk borrower from the lender’s point of view? and what criteria do they use to evaluate me on the risk scale?
Characteristics of high-risk mortgages
Low down payment
The more the amount of money you put down as a down payment for your home the more invested you are in that property. From the lender’s perspective, the more invested you are in that property the lower the chances are that you will default or allow it to go in foreclosure because you also stand to lose a lot. So if you put down less than 20% of the purchase cost of the Park Grove Miami home then the lender will probably insist that you buy insurance from a PMI company.
A High loan-to-value ratio, LTV
This is a figure derived by dividing the amount of the loan by the value of the home. The higher this figure is then the riskier the mortgage is. What this means is that the amount of the loan is higher than the value of the home and consequently means that even if the property were to be sold at its current market value It will not break even against the loan. Mortgages with an LTV ratio greater than 80% require that PMI be paid. Because this basically means that the borrower owns less than 20% of the value of the property and from the lender’s perspective is not invested enough to avoid all scenarios that lead to default or foreclosure.
How to avoid paying PMI
Put 20 percent down payment or more.
From the borrower’s perspective, PMI might seem like a punitive measure from the lender. But if you look at it from the lender’s perspective, they are providing you with financing for your Park Grove Miami home with your down payment as the only tangible collateral. So by making a down payment of at least 20% of the purchase price of your home speaks to the level that you are invested in the property. It also sets your loan-to-value ratio at 80% and as we discussed earlier, the lower the loan-to-value ratio, the lower the risk associated with that property. The best way to raise the down payment is through diligent saving and reducing costs in your current living situation.
You can opt to live in a smaller space that costs less and put aside the difference in a deposit account. Secondly, you can take side jobs and save up the extra income as you try to raise the down payment. But if raising the loan-to-value ratio through this method is infeasible for you then there are other methods which we’ll look at below.
Take a second mortgage
Another way of reducing the loan-to-value ratio is by taking out a second mortgage on the same property. This is called a piggyback mortgage because it basically rides on the back of the other mortgage. So this is how it works, the second mortgage also called the home equity loan is taken out at the same time as the first mortgage on your Park Grove Miami home.
So now we have three components, we have 2 mortgages and your down payment. So 80% of the purchase price of your Park Grove Miami home will be covered by the first mortgage you take out. Then you can take out a second mortgage that will cover 10% of the purchase price. This leaves 10% that you will now pay as a down payment. As you can clearly see, the advantage of this scheme is that it reduces your actual down payment from 20% to 10%. So by taking out two mortgages, it ensures that no single loan constitutes more than 80% of the purchase cost of your Park Grove Miami home, maintaining a low LTV.
Lender paid mortgage insurance
The third way of reducing the impact of the PMI on your cash flow is a situation where the cost of the PMI is included in the mortgage interest. So rather than directly being included in your monthly payments it is factored into the interest rate and distributed over a longer period of time, which is the life of the mortgage. An adjusted interest rate is easier on your pocket than a direct monthly cash deduction. So although you may end up paying a higher interest over the life of the mortgage the situation might be more manageable for you and have less impact on your cash flow situation.
So these are the three most common ways of avoiding direct PMI payments if you’re planning on financing the purchase of your Park Grove Miami home through a mortgage.