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If you are not able to make at least 20% down payment on your home, then you’ll have to purchase a Private Mortgage Insurance policy. It is commonly referred to as PMI. It protects the mortgage lender if the borrower defaults on loan repayment. PMI is usually based on a percentage of your mortgage loan that you need to pay every month. Therefore, it varies with your credit risk and the amount of your home loan.

Types of Private Mortgage Insurance

Private Mortgage Insurance policies can be categorized into 2 types - (1) Borrower-paid PMI and (2) Lender-paid PMI. Each of the 2 types is discussed below.

1. Borrower-paid Private Mortgage Insurance: It is a type of Private Mortgage Insurance policy wherein the borrower pays the insurance premium. Generally, a mortgage borrower needs to purchase this policy when he/she is unable to afford 20% down payment on a home loan. It is also referred to as Borrower-paid Private Mortgage Insurance (BPMI) or Traditional Mortgage Insurance.

2. Lender-paid Private Mortgage Insurance: In Lender-paid PMI (LPMI), though the lender pays the premium cost of PMI, yet ultimately, the borrower has to bear the premium cost. Usually, lenders add the premium cost with the mortgage loan interest. Generally, a lender buys this insurance policy in case of high loan-to-value mortgage.

How to avoid Private Mortgage Insurance

You can avoid PMI even if you’re unable to make 20% down payment on your home. Here are some ways following which you can avoid purchasing a PMI policy.

Go for an 80-10-10 home loan: In this loan program, you’ll have to take out 2 loans along with paying 10% down payment on your home. The first mortgage finances 80% of the sale price and the second mortgage finances the remaining 10%. It is also referred to as piggyback loan.

However, it may not be possible for you to take out a piggyback loan in present times. Lenders are not offering this loan due to credit crunch that started in 2007.

Pay more interest on your mortgage: You can avoid PMI by paying more interest on your mortgage loan. Most of the times, the lenders waive off PMI if the borrowers pays more interest on the home loan.

Borrow from your friends/family members: You can borrow the required amount from your friends or family members. It is advisable that you mention the terms and conditions of repayment in writing so as to avoid any misunderstanding in future.

When you purchase Private Mortgage Insurance, it is quite important that you cancel it once you’ve repaid 20% of your home loan so that you only have 80% loan on your home. However, it may take a much longer time as most of your initial payments go towards the interest; you cannot pay much towards your principle in the initial period of the loan term. Most lenders allow borrowers to cancel PMI after 2 years of on time payments.

Most people realize that having good credit scores is vital for getting a mortgage loan approved, but this is not everything that the lender takes into consideration. There are several key factors that a mortgage lender looks at when determining whether or not to approve a loan and only part of this information is contained in a credit report. This is why most people applying for a mortgage are required to present much more documentation than the lender can obtain independently.

One of these key factors is the applicant’s debt ratio. This is the ratio of an individual’s debt and expenses to his net income. The lender compares the potential borrower’s current debt load and living expenses with his income. This is why applicants are expected to provide pay check stubs, tax returns, and other documents that cannot be obtained from the credit reporting agencies. The ideal debt ratio is about 1.3, meaning that the applicant has about 30% more income than is required to pay for his current debt and expenses.

Another important factor that mortgage lenders look at is the applicant’s payment history, specifically looking for late payments. Mortgage lenders consider the timeliness of payments to be extremely important. This information is found in the credit report, but is given a different weight in the FICO score than the weight that the mortgage lender gives it. For this reason, the lender will review the applicant’s credit report in detail, beyond just the overall score, looking to see whether or not the applicant has a habit of making his payments on time. If the client has a number of late payments in his credit report, this is one instance where a letter of explanation appended to the loan application might be helpful in explaining the problem.

Mortgage lenders also look at the applicant’s other assets besides his regular income to determine if the applicant has the means of making an equity investment, or down payment. If the client has large additional assets and they are fairly liquid - like a large stock portfolio - this may help offset other factors, such as a less than optimal debt ratio. If the applicant has enough additional assets to make mortgage payments outside of his regular income, this is viewed favorably by most lenders. This information is usually not included in a credit report and is why a mortgage lender will ask for statements from the applicant’s brokerage accounts and retirement accounts (IRAs, 401(k), etc.).

Another factor that lenders take into account has nothing to do with the applicant’s financial position, but deals with the property in question. All mortgage lenders will require a comprehensive appraisal of the property that the applicant is seeking to purchase. This prevents the lender from lending out more money than the property is worth. Should the loan turn bad and result in foreclosure, it is crucial to the lender that the resell value of the property be enough to cover the amount originally lent out.

Knowing what the mortgage lender looks for can help the potential home buyer get their application in good form. The above can help the potential mortgage seeker determine what elements of his financial position should be changed or corrected to make approval more likely.