The Alternatives to Mortgage Insurance, Such as a Piggyback Loan or Larger Down Payment

Mortgage insurance is often an inevitable part of homebuying for potential buyers who cannot afford a 20% down payment. Lenders are only willing to extend financing if borrowers reduce their risk by obtaining insurance. However, it adds to the borrowers' homebuying cost.

Nevertheless, you have different mortgage insurance alternatives that can lead to substantial savings and reduced monthly payments. These options are easy to manage, and borrowers often opt for them to fit their financial situation.

Today, we will discuss different options for escaping insurance and financing your home more cost-effectively.

Key Takeaways

Mortgage Insurance and its Avoidance

Mortgage insurance is usually required when homebuyers make a down payment of less than 20% of the home's purchase price. Sometimes, the borrowers do not have enough upfront funds for initial investment, so they need the lender's support. However, as those people are high-risk borrowers, lenders need protection from default and foreclosure risk. Thus, borrowers are required to obtain insurance to offset the lenders' risk. 

While necessary from the lenders' perspective, the insurance represents an additional monthly expense for buyers. Borrowers must pay an extra fee along with their principal and interest, calculated as a percentage of the loan amount. This extra fee is called the mortgage insurance premium (MIP) or private mortgage insurance (PMI), depending on the type of loan. MIP refers to insurance premiums on FHA loans, while PMI is used for conventional loans.

However, mortgage insurance alternatives can save you from paying insurance premiums. These options allow for potential financial relief, savings, reduced monthly payments, and flexibility in managing personal finances, making homeownership affordable. In addition, some alternatives, like piggy bank loans, often have tax deductibility benefits. Furthermore, you can build home equity faster, as your budgeted payments go toward the principal balance instead of insurance premiums.

Mortgage Insurance Alternatives

Mortgage insurance alternatives offer borrowers options to avoid paying mortgage insurance premiums while still financing their home purchase. Here is an overview of these alternatives:

• Piggyback Loans (Combo Loans)

  A piggyback loan, also known as a combo loan, involves taking out two separate loans simultaneously: a primary mortgage for the majority of the purchase price and a second mortgage (or home equity line of credit) to cover the remainder of the down payment. Common piggyback loan structures include the 80-10-10 or 80-15-5 arrangements, where the first number represents the percentage of the purchase price covered by the primary mortgage, the second number represents the percentage covered by the second mortgage, and the third number represents the down payment.

  This strategy avoids paying private mortgage insurance (PMI) by making a larger down payment upfront. Lenders usually waive PMI requirements for loans with a combined loan-to-value (CLTV) ratio below 80%.

• Larger Down Payment

  The most straightforward method to avoid mortgage insurance is to make a down payment of at least 20%. This mortgage insurance alternative reduces the loan-to-value (LTV) ratio, diminishes lender risk, and qualifies you for improved loan terms and rates, removing the need for insurance. While this requires higher upfront costs, it lowers overall monthly payments and long-term cost savings. In addition, your monthly payments are directed toward the principal balance so you can build home equity more quickly. 

• Lender-Paid Mortgage Insurance (LPMI)

  In LPMI, the lender pays the insurance premium upfront or throughout the loan term, and usually, this cost is covered by a slightly higher interest rate for the borrower. It allows borrowers to avoid paying separate PMI premiums but may result in marginally higher overall interest costs over the life of the loan.

  However, LPMI is a good mortgage insurance alternative as it removes the monthly insurance fee for borrowers and can be beneficial depending on the loan's terms and duration, as the insurance expense is distributed throughout the loan. In addition, the borrowers can take advantage of mortgage interest tax deductibility and subtract the extra interest charged by lenders for covering LPMI if they itemize their deductions. 

• Government-backed Loans

  Government agencies offer different loans with varying insurance or no insurance requirements. 

  • FHA Loans

    While FHA loans require upfront and annual mortgage insurance premiums (MIP), they offer low down payment options for borrowers with less-than-perfect credit. For FHA loans initiated on or after June 3, 2013, your MIP may be discontinued after 11 years if you make a down payment of 10% or more. Conversely, MIP for loans issued before June 3, 2013, can be terminated after five years if the loan-to-value (LTV) ratio reaches 78%.

  • VA Loans

    VA loans, available to eligible veterans, active-duty service members, and qualified spouses, do not require mortgage insurance, even with zero down payment. However, VA funding fees may apply.

  • USDA Loans

    USDA loans support rural development and facilitate homebuying in rural areas. They do not require a down payment. However, they include an upfront guarantee fee and an annual fee that function similarly to mortgage insurance. The upfront fee can be financed into the loan, and the yearly fee is paid monthly. These loans are ideal for eligible rural and suburban homebuyers who meet income criteria. Unlike FHA loans, the fees for USDA loans remain in place for the life of the loan.

Wrap-Up

Homeowners have several viable options to reduce or eliminate their mortgage insurance needs. Understanding the mortgage insurance alternatives can lead to significant savings, offering borrowers flexibility in structuring their home financing. However, each option has advantages and considerations, and borrowers should carefully evaluate their financial situation, goals, and eligibility criteria when selecting the most suitable alternative. 

Consulting with a mortgage professional can provide valuable guidance in exploring these alternatives and determining the optimal financing strategy for purchasing a home.

FAQs

1. Are piggyback loans more expensive in the long run?

It depends on interest rates and loan terms. Sometimes, the second mortgage in a piggyback loan might have a higher rate, which could increase costs over time compared to a single loan with mortgage insurance.

2. Can I remove mortgage insurance if I increase my home's value through renovations?

Improving your home's value through renovations could lead to a reevaluation of your loan-to-value ratio. If it decreases to 80%, you might be eligible to request insurance removal, and insurance will automatically cancel if it falls below 78%. However, you must consider your loan type and lender's policies.

3. 8How does refinancing affect mortgage insurance?

Refinancing can be a strategic way to eliminate insurance if your home's value has increased or if you have paid down a significant portion of your mortgage, thus lowering your loan-to-value ratio. You might be able to remove insurance by refinancing into a conventional loan with a better LTV ratio.