Private Mortgage Insurance is an added cost, but could it help you save money on a down payment?
Most home buyers need a mortgage to purchase a property. In most cases, the lender requires the buyer to put some money toward the purchase – this is the down payment (closing costs are something different, but also required). There are a lot of different loan programs out there, but a buyer can put down as low as 3% of the purchase price of the home.
When a buyer makes a down payment of less than 20%, the lender considers the buyer a higher risk. Private Mortgage Insurance (PMI) protects the lender in case the buyer stops paying the mortgage. This insurance reduces the lender’s financial risk. The insurance is purely for the benefit of the lender – the buyer has to pay this insurance for the opportunity to make a low down payment that is under 20% of the purchase price.
How does PMI factor into my mortgage payment?
PMI is paid monthly, usually as part of the mortgage payment. It can range between .58% and 1.86% of the loan amount usually depending on the borrower’s credit score. So if you buy a $300,000 home with a down payment of $10,000 (5%) and have a 700 credit score, your approximate PMI monthly payment will be $188. Nerd Wallet has an excellent PMI calculator. There are different loan programs out there, so this information is approximate.
PMI does go away after a while though. Once the balance of your mortgage is 80% of your home’s value, the insurance premium will drop off your payment – you’ve hit that 20% I talked about above. That of course, will take years.
Is there a benefit to PMI?
So why buy a home unless you can get together the full 20% downpayment, especially if you have to spend money on an insurance premium that doesn’t even benefit you? There are two good reasons:
You don’t need as much cash to be able to buy.
In our $300,000 example above, a 20% downpayment is $60,000, and that doesn’t even include closing costs.
A lower downpayment can mean that you become a homeowner sooner.
In this market, housing prices are still going up. Paying PMI now might be a good idea because prices continue to rise and the down payment will be even higher down the road.
If you’d like to take a deeper dive, Freddie Mac has excellent information on PMI, including a short video. As in any purchase, there are always trade-offs to “buy now or buy later.” And despite the extra expense of PMI, a lower downpayment can create an opportunity for you to own your own home, which is always a good idea.