When buying a home, lenders typically like to receive at least 20% down. While it is possible to purchase a property with a lower down payment, it comes at a higher cost because the lender will require the homebuyer to pay private mortgage insurance, or PMI. This article explains what PMI is, how it may affect you as a homebuyer, and possible ways to avoid having to pay it.
What is private mortgage insurance?
Private mortgage insurance is a type of insurance banks or lenders charge homebuyers who receive a conventional loan in which they put less than 20% down. PMI may also be charged if there is less than 20% of the equity in the home when refinancing. This insurance protects the lender in the event the homeowner defaults or stops paying the mortgage.
Your PMI payment is an additional fee that is charged on top of your monthly principal and interest payment for your mortgage, property insurance, and taxes. The monthly payment for PMI ends on a predetermined date provided by your lender when the loan was originated, or when your principal balance is below 78% of its original appraised value.
How much does it cost?
PMI can cost anywhere from 0.41% to 2.25% and is largely determined by your credit score, loan-to-value (LTV) ratio, and debt-to-income (DTI) ratio. Most commonly PMI is charged to the homebuyer in the form of a monthly payment, although some banks may charge PMI as a one-time up-front payment as a part of the loan, or a mixture of both.
If you want to purchase a $300,000 home but only have 10%, or $30,000, to put down, the bank would charge you PMI. If you receive a reasonable rate of 1% PMI, you would be paying $225 extra per month for private mortgage insurance. You would pay $16,527 in PMI alone over the period of time it takes you to reach 20% in equity. At that point, the additional PMI charge is canceled.
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How can I avoid having to pay PMI?
Private mortgage insurance has no benefit for the homeowner, and as of 2018 is no longer tax-deductible. For this reason, it is suggested that homeowners avoid having to pay PMI if at all possible. Below are several ways you can avoid having to pay PMI or reduce how much you pay in mortgage insurance over the life of the loan.
Put at least 20% down
The easiest way to avoid having to pay private mortgage insurance is by putting at least 20% down on a property when getting a conventional loan, or not refinancing the home for more than 79% of its current value. Continue to save diligently until you reach 20%, or possibly buy a home at a lesser value that allows you to pay a 20% down payment now.
Consider getting a USDA or VA loan
It may be beneficial to consider a government-insured loan such as a Veteran Affairs (VA) loan or a Department of Agriculture (USDA) loan which does not require mortgage insurance. While FHA loans do not charge PMI, they do come with two types of their own mortgage insurance premiums.
Receive down payment assistance to reach a 20% down payment
Down payment assistance programs can help homeowners increase the amount of money they have to put down when buying a home. While these programs may help the homebuyer reach a 20% down payment, it can be difficult to qualify for one of these programs because of their strict eligibility requirements. Unison offers an alternative down payment assistance program in which it provides the buyer with additional funds to reach a 20% down payment in exchange for sharing a portion of future appreciation on the home. This can be a costly program, so it’s important to compare the costs over time and determine if it’s worthwhile to receive assistance or not.
Use appreciation and mortgage paydown to your advantage
If none of the above are an option, there are other ways to reduce how much PMI you pay. The easiest is by paying down your mortgage aggressively. Make additional payments each month to pay down your mortgage faster. This reduces the amount of interest you pay over time, while also increasing the equity you have in your home. Keep an eye on the market and look at what similar properties in your neighborhood are selling for. If your property appreciates at a faster rate than anticipated, request the lender to have a formal appraisal done. If you have 20% or more in equity, you can formally request the PMI be canceled.
In summary, private mortgage insurance can be an expensive added cost. It is typically in the homebuyer’s best interest to be able to put 20% or more down in order to avoid having to pay PMI, but there are alternative solutions if it’s simply not possible at the time of purchase.