Here’s the good news: You can totally buy a house even if you don’t have 20% ready to go for the down payment. But here’s the bad news: You’re probably going to need private mortgage insurance. Here, we break down what that is, why it matters, and even how to possibly get out of it.
What Is Mortgage Insurance?
“Mortgage insurance, also known as private mortgage insurance or PMI, is required for home buyers who finance more than 80% of the home’s value with a conventional mortgage,” says Insurance Analyst Kent Thune of FitSmallBusiness.com. In other words, if your down payment is less than 20% of the sale price, you’re going to have to borrow more than 80% of the cost of the home, and need mortgage insurance.
“The cost of PMI is usually between 0.5 percent and 1.0 percent of the mortgage per year, and is usually included in the total monthly mortgage payment.”
So how much will that be? “The cost of PMI is usually between 0.5 percent and 1.0 percent of the mortgage per year, and is usually included in the total monthly mortgage payment,” Thune says.
But mortgage insurance isn’t just for those with a smaller down payment. It’s also required for all Federal Housing Authority (FHA) loans, says mortgage broker and Realtor Michael Hausam. And if you’re merely refinancing as opposed to buying a new home, don’t expect to get out of it that way either, he says. “It is also usually required on a refinance when there is less than 20% equity.”
Make no mistake, PMI is designed to help the lender. As Danielle Pennington, a loan officer at BestWay Mortgages, explains: “When someone puts down less than a 20% down payment, lenders look at this as an increased risk for default and therefore, they want to have insurance in case the borrower defaults on paying back the loan. Mortgage insurance protects the lender NOT the borrower.”
Like other insurance premiums (as well as interest rates), mortgage insurance isn’t a flat fee. The amount you pay is based on several factors including “the borrower’s credit score, amount of down payment, type of dwelling and if it is a primary or secondary residence as well as the loan term (30, 20, 15, etc. year term),” says Elysia Stobbe, author of How To Get Approved for the Best Mortgage Without Sticking a Fork in Your Eye.
For borrowers with good credit and a healthy down payment, PMI may be quite small. But for those who don’t have the best credit or don’t have much money to put down, the mortgage insurance can add up, not just because the fee is higher, but because the buyer is paying it for a longer amount of time.
Ways to Avoid PMI
The most obvious way to avoid PMI is to put 20% down. But that’s not always possible for a buyer to do. Still, there are alternatives.
“Many lenders are offering ‘lender paid PMI’ which will essentially result in an increase to the interest rate on the loan, in exchange for the lender ‘paying’ the PMI for the borrower,” says Kevin Deselms, a Realtor with RE/MAX Alliance in Golden, CO.
“You can ask your lender if they offer Piggyback Loans,” says Pennington. “In this scenario,” she says, “the buyer would put 10% down as a down payment on a home and then take out two mortgages simultaneously, one for 10% and one for 80%. The borrower’s 10% down payment combined with the second ‘Piggyback’ Mortgage for 10% would eliminate the need for PMI.”
If you’re a veteran, you may qualify for a VA loan. Those do not require mortgage insurance.
Different lenders will have different offerings, and the rates and fees will always vary from borrower to borrower, so it’s most important thing is to go over your options and determine how you can save the most money.
“For a single dwelling, the mortgage insurance is automatically removed when the amortization schedule hits 78% loan to value (or 22% equity).”
Regardless, if you can’t avoid paying PMI, know that most likely you’ll get out of it eventually. “For a single dwelling, the mortgage insurance is automatically removed when the amortization schedule hits 78% loan to value (or 22% equity),” says Stobbe. In other words, keep paying your mortgage on time, and once you hit that 22% mark, the fee will fall off on its own.
There’s also an option for those who don’t want to wait that long, she says. A borrower may also request to have PMI removed when the equity in the house hits 20%, but a new appraisal may be required.
Why NOT to Avoid PMI
While additional fees always seem like a burden, some experts say having mortgage insurance isn’t really the worst thing.
“There are definitely benefits to taking on mortgage insurance!” Pennington says. “A 20% down payment can be a huge financial burden for some people; if this was the only option for purchasing a home, many homebuyers would delay homeownership or maybe even never be able to buy. Lower down payment options make homeownership accessible to the masses.”
Even if a borrower has 20% in the bank and ready to go, Pennington adds that it’s not always the right decision to plunk all of that money into a house. “Often times, borrowers who do have the 20% down payment will choose to put down less and keep their own money accessible to them for other options: investments, home repairs, etc.”
Blake Janover, founder of home.loans, says that if the worst happens, a borrower might be very thankful they have PMI. “Although people often try to avoid mortgage insurance,” he says, “it can be helpful in the event of a default. Since the insurance is designed to ensure that the bank comes out of a foreclosure losing as little money as possible, that also means that you will owe as little money as possible if you’re in [recourse state], where the bank can sue you for whatever balance is left after the sale.”
That’s certainly a much bigger fee than mortgage insurance will ever be.
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