Buying a home usually has a monster obstacle: coming up with a sufficient down payment. How much you put down on a conventional mortgage — one that’s not federally guaranteed — will determine whether you’ll have to buy PMI, or private mortgage insurance.
Typically a lender will require you to buy PMI if you put down less than the traditional 20%.
» MORE: Down payment strategies
What is private mortgage insurance?
PMI is insurance for the mortgage lender’s benefit, not yours. You pay a monthly premium to the insurer, and the coverage will pay a portion of the balance due to the mortgage lender in the event you default on the home loan. The insurance does not prevent you from facing foreclosure or a decrease in your credit score if you get behind on mortgage payments.
PMI is insurance for the mortgage lender’s benefit, not yours.
The lender requires PMI because it is assuming additional risk by accepting a lower amount of upfront money toward the purchase.
Mortgage insurance for federally guaranteed loans, such as FHA loans and USDA loans, operates a little differently from PMI for conventional mortgages. VA loans don’t require mortgage insurance, but do include a “funding fee.”
» MORE: What Is mortgage insurance?
How much does PMI cost?
The average annual cost of PMI typically ranges from 0.55% to 2.25% of the original loan amount, according to Genworth Mortgage Insurance, Ginnie Mae and the Urban Institute.
The cost of private mortgage insurance is based on the size of the mortgage loan, and your down payment and credit score. PMI will cost less if you have a higher credit score and a larger down payment.
PMI will cost less if you have a higher credit score and a larger down payment.
The PMI cost, often called a “premium,” is added to your monthly mortgage payment. Estimating the cost of PMI before you get a mortgage can help you determine how much home you can afford.
» MORE: Calculate your PMI
When can you stop paying PMI?
Once your mortgage principal balance is less than 80% of the original appraised value or the current market value of your home, whichever is less, you can generally get rid of PMI. Often there are additional requirements, such as a history of timely payments and the absence of a second mortgage.
How to avoid PMI
Mortgage insurance allows a lot of people to become homeowners who otherwise might not be able to. And it’s natural to want to put down as little money as possible, but make sure you consider the real costs, like paying for mortgage insurance.
A larger down payment offers advantages beyond lowering the monthly mortgage payment. You’ll also get a lower mortgage interest rate, pay fewer fees and gain equity in your home faster. And if your down payment is big enough, you’ll avoid PMI altogether. But ultimately it’s a matter of balancing your short-term financial capabilities with the realities of your local real estate market, and your future savings and earnings potential to determine the best long-term financial result for you.