Private mortgage insurance (PMI) is charged to borrowers when their down payment is less than 20% of the home price. Generally if a potential home buyer is borrowing a mortgage for anything more than 80% of the purchase price, he/she will be required by a lender to pay PMI. The payments are requested because lenders perceive a higher risk associated with borrowers who do not have 20% to put down on a mortgage.

PMI is costly and adds to your monthly payment, but there are a few options to avoid paying PMI or to reduce the payment considerably. Ask your lenders what they options they have.

1. Pay it Upfront

If you have the cash, consider paying PMI in a single premium upfront during the closing proceedings. By paying it upfront you can reduce your monthly payment. You can also finance this premium and include it in your mortgage.

2. Increased Interest Rate

Many lenders will pay your PMI for you but in return they will raise the interest rate. In this case, you need to calculate how much your monthly payment would increase with the higher interest rate as compared to how much the monthly payment would increase with PMI added on. In most cases a higher interest rate will equate to lower monthly payments.

Example: You are considering a 30-year fixed mortgage with an interest rate of 5.25% for a $200,000 mortgage at 95% financed (you are putting down 5%):

Monthly mortgage payment = $1104

Your PMI due to a less than 20% down payment equates to about $130 / month.

Your total monthly mortgage payment would be – $1104 + $130 = $1234

If your lender decides to pay the PMI yet offers you an interest rate of 5.75% in exchange…

Monthly mortgage payment = $1167

The difference in payments is $67 more ($1234 – $1167) with the lower interest PMI option.

Note: Your PMI payment will depend on several factors unique to your financial situation. Sit down with the numbers and calculate your savings with each scenario. Also keep in mind many lenders will cancel PMI payments after a number of years or if a certain level of equity is reached. Consider this as well as refinancing when making your decision.

3. Piggyback Loan

A popular method to avoid PMI is getting a second loan to cover the 20% down payment. The first loan would cover 80% of the purchase price and the second loan would cover the remaining 20%. The only drawback to this loan, aside from the difficulty of getting a second mortgage approved by lenders today, is the high interest rate on the second loan.

Your decision to use this method will depend on how much cash you actually have and what your payments will be with the higher interest second loan. If you have cash available for a down payment, you can get a loan for the remaining amount. For example, a common loan is an 80-10-10, which denotes a first loan of 80%, a second loan of 10% and 10% for a cash down payment.

4. PMI Elimination

Some lenders will eliminate the PMI after two to five years if you are in good credit standing and you haven’t missed a payment. Additionally, if you’ve built up at least 20% equity in your home, you may be able to cancel your PMI payment as well. Note: Some government backed loans (FHA, VA) may require you to pay PMI throughout the life of the loan or for a longer period of time than a traditional loan.

5. PMI Cancellation

If you want to request the cancellation of your PMI payments you will need to submit your request in writing to your lender. Call to ask what is needed then request a formal letter stating what property value is needed to cancel the PMI. Your lender will most likely appraise your property (you are responsible for the fees) to address your request. Do not request a cancellation if your payments have not been made on time. You will most likely waste your time and money.

The best way to avoid PMI is to buy a home you can afford. If you have cash for a down payment, it may be worth downsizing your expectations to fulfill the 20% minimum down payment  to avoid PMI. If you decide to go forward with a lower down payment, discuss your options with your lender. Before deciding  on a piggyback loan, request a higher interest rate in return for the bank to pay your PMI. Mortgage interest is tax deductible and PMI may or may not qualify for a deduction. Assess each option carefully and determine which fits into your budget and future financial outlook.