You can buy a house with less than 20% down and avoid having to pay monthly PMI. Here is how.
There is a little known mortgage insurance product which is an alternative to the traditional monthly mortgage insurance. It is called LPMI which stands for Lender Paid Mortgage Insurance. In exchange for choosing a slightly higher interest rate the lender covers the mortgage insurance for you. The savings can be significant by choosing this option even though you do pay the higher interest rate for the life of your loan where the traditional monthly mortgage insurance can eventually be removed.
Consider the following scenario where you are buying a $200,000 house putting 5% down and your credit score is a 740
Traditional Monthly LPMI
Interest Rate 4.000% 4.375%
Monthly payment $1005.26 $ 948.64
Savings after 5yrs ---- $2347.93
Savings after 10 yrs ---- $3422.11
The above savings assumes that you aren’t prepaying on the principal. Also, because you have elected the higher interest rate in lieu of the monthly mortgage this can provide for a larger mortgage interest tax deduction on your federal income taxes where the traditional monthly mortgage insurance cannot be a tax write-off which can result in an even greater savings for the LPMI than what is reflected above. Please consult your tax advisor regarding the deductibility of mortgage interest. Lastly when comparing these options please note that after 15.75 years the traditional monthly option would start to become the cheaper option but from my experience the majority of my clients that take out a 30 year mortgage keep it for that long due to relocation or refinance.
Another option is to pay a fee to the lender in lieu of a higher interest rate. In the above example it would cost you an additional $4085 at closing to keep the 4.00% interest rate. Alternatively, the $98.17 monthly mortgage insurance can be on the loan for up to 111 months which would cost you $10,896.87. So by paying the $4085 up front you would save up to $6811.87 over the next 9.25 years.
To determine which option is best for your situation you need to consider your desired monthly payment, availability of funds for closing, and length of time that you plan to keep the loan.