How You Can Avoid Private Mortgage Insurance
If you have been planning to buy your dream home, you probably know that you will have to set aside 20-25 per cent of the cost of the property for down payment, or margin money. The rest can be financed through a home loan. But what if you are unable to arrange funds for the margin money? In such cases, your lender will ask you to secure a private mortgage insurance (PMI) before the loan agreement is signed. A PMI is one of the risk-mitigating tools for banks in case of default in your payments.
MakaanIQ tells you all you need to know about PMI and how you can avoid it.
What is PMI?
A PMI is a type of mortgage insurance used with conventional loans and can be arranged by your lender or private insurance companies. A PMI covers the bank's loss if you stop making payments on your home loan.
If you are liable to pay monthly mortgage insurance, the PMI payment is in addition to your equal monthly instalments (EMIs) and property taxes. You can either pay a lump sum amount for your mortgage insurance or avail of a loan for it.
Problems with PMI
Cost: A PMI typically costs 0.5-1.00 per cent of the entire loan amount on an annual basis. The cost of PMI varies, depending on the loan amount, the level of your equity in the secured property and the level of the risk associated with a particular loan product. Some lenders allow you to add the cost of the PMI premium to to your loan amount which means you do not have to pay amount upfront. However, this leads to a marginal increase in your loan repayments, to include the cost of the PMI premium.
Tax benefits may/may not be there: Those who pay the premium for a term plan or loan insurance are entitled to claim tax benefits under Section 80(C) of the Income Tax Act. But, if your premium is fused with the EMIs, you cannot claim a tax deduction on the insurance premium plan.
This means, if your loan amounts to Rs 30 lakh and the premium to insure it is Rs 50,000, your total debt will be Rs 30.50 lakh. Now, your EMI will be calculated on Rs 30.50 lakh, and not Rs 30 lakh. In such a case, you may not be able to avail of tax benefits.
Family gets nothing: Home loan buyers assume that their spouse or other family members receive monetary compensation in case of a mishap. But this is not true of PMI. A loan insurance is the risk-mitigating tool to cover the lender's risk; the lending institution is the sole beneficiary of any such policy. The proceeds are first paid to the lender, and not the family/heirs.
Hard to revoke: In principle, if a borrower's equity crosses 20 per cent in a PMI, he no longer has to pay the EMI. However, eliminating the additional monthly burden of insurance can be a cumbersome and time-consuming process. Many lenders may ask you to draft a letter requesting that the PMI be cancelled, which can make you lose the money you have paid so far.
Perpetual payment: Some lenders require home loan buyers to maintain the PMI agreement for a fixed/entire loan period. So, even if the borrower has met the 20 per cent threshold, he might still be obligated to make the monthly payments.
Can I avoid paying for PMI?
While being ready with a down payment is the best option to avoid paying for PMI, you have other options, too.
- Some credit unions can waive PMI, in spite of the low margin money, if your case is strong. A good credit score and a clean debt payment record will come handy in such a situation.
- Paying a higher loan interest rate may help you avoid a PMI. This amount will be applicable throughout the loan tenure.
- There are some government programmes that help you buy on no/zero down payment, if you take the risk of investing in the qualified rural areas.
- Understand the terms and conditions of your loan agreement and calculate your loan-to-value ratio to avoid paying PMI longer than absolutely necessary. Knowing when and how to remove your PMI will reduce your monthly mortgage bill.
- If you are backed by a guarantor, who commits to paying an agreed amount, it may help you secure a home loan without having to opt for a PMI. A guarantor brings safety to your loan from the lender's point of view.
Should you buy a home with no down payment?
Now that you know there are options for buying a home with no down payment, the question remains whether it is a good idea.
- If you play your cards right and conduct a proper research, you might end up getting the best interest rate deal, when you contribute the required margin money.
- Quite obviously, by paying the portion of the cost of the house upfront, you will be closer to getting the house paid for than a situation where you start with no equity.
- A PMI option can be risky for both the borrower and the lender. The burden will get shifted to your family in case of any mishap and the bank might lose its money in such a scenario.