Difficulty: Easy

Average Score: 100%

What type of conventional loan should a buyer choose to avoid paying PMI?

Rationale

A) a loan with an LTV of 80% or lower

To avoid paying Private Mortgage Insurance (PMI), a buyer should choose a conventional loan that has a Loan-To-Value (LTV) ratio of 80% or lower. This means that the buyer is making a down payment of at least 20%, which eliminates the requirement for PMI, a cost incurred for loans with higher LTV ratios.

B (a budget loan with a 10% down payment) YOUR ANSWER

A budget loan typically requires a down payment of only 10%, resulting in an LTV of 90%. This higher LTV means that the borrower will be subject to PMI, as lenders require insurance on loans that exceed 80% of the property's value to mitigate their risk.

C (a package mortgage, which requires an LTV of 86%) YOUR ANSWER

A package mortgage with an LTV of 86% signifies that the buyer is financing 86% of the property’s value, necessitating a down payment of only 14%. This LTV is above the 80% threshold, thus requiring PMI to protect the lender against potential default.

D (an ARM, which starts at 95% LTV then adjusts after 5 years) YOUR ANSWER

An Adjustable Rate Mortgage (ARM) that starts with a 95% LTV indicates that the borrower is making a down payment of only 5%. This extremely high LTV means PMI will be required, as it exceeds the 80% limit that allows buyers to avoid this additional cost.

Conclusion

To avoid PMI on a conventional loan, buyers should aim for an LTV of 80% or lower, necessitating a minimum down payment of 20%. Options with higher LTV ratios, such as those mentioned in the other choices, will incur PMI costs. Understanding these ratios is crucial for buyers looking to minimize their mortgage expenses.

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