Home Buying Tips: How to Avoid PMI and Why You Might Not Want To
Every homebuyer has been told to avoid PMI. But what is PMI, and why is it so terrible? PMI stands for Private Mortgage Insurance. Lenders used to expect a buyer to prove that he (they didn’t loan to women) had the self-discipline necessary to save up a 20 percent down payment.
Eventually, lenders decided this wasn’t necessary, although they were still wary of borrowers who put down less. Private Mortgage Insurance was created to ease their minds. PMI is insurance that pays out to the lender in case of default. It’s a bit like purchasing a co-signer. Unfortunately, PMI is expensive. Luckily, it can be avoided.
Putting down 20 percent is the best and simplest way to avoid PMI. You will sidestep PMI altogether, your monthly payments will be dramatically lower and your interest rate might be, too. You will also have built-in home equity.
Piggyback Loans with HELOC: If 20 percent down is not desirable or possible, “piggyback” loans are one alternative. The first mortgage will be for 80 percent of the home’s value, and a second mortgage or Home Equity Line of Credit (HELOC) for 10 to 20 percent of the home’s value will be arranged. Drawbacks include a higher interest rate or even an adjustable rate (ARM) on the second loan. Also, beware of balloon payments that require you to pay off a loan all at once.
If you find an extremely good deal that won’t last or if you are paying high rent that you will never get back, anyway, then paying more for either PMI or a higher interest rate may be cheaper in the long run than waiting to buy. Speak frankly with your mortgage broker or financial planner and have him or her run the numbers so you can determine the best deal for you.
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