Could you buy your dream house without a 20-percent down payment? Learn how PMI can help make it happen.
Scraping together that all-important 20-percent down payment to buy a new house can seem like an insurmountable challenge. But for those who don’t quite have a full 20 percent saved up, but are still ready to start searching for their first home, there’s a solution: private mortgage insurance, or PMI. But what is PMI?
Private mortgage insurance, also known as PMI, is an insurance policy on the balance of your home loan, and homebuyers who put down less than 20 percent on a home purchase are typically required to carry it. PMI reassures the lender that the home loan will still be paid even if the homebuyer defaults on his or her mortgage, and it allows homebuyers to get a home more quickly without saving up a substantial down payment.
1. The cost of PMI.
PMI can cost anywhere from 0.2 percent to 1.5 percent of your loan amount on an annual basis, depending on how much money you put down and your credit score. That can add up, but PMI is simply the cost of bypassing the traditional 20-percent down payment. For many homebuyers, it’s worth it.
Here’s the math: On a $200,000 loan with no down payment, you could find yourself paying anywhere from $33 to $250 per month for PMI. Some homebuyers may see that as an unnecessary added cost. For others, it’s a small price to pay to get into a house.
2. How to pay PMI.
Your PMI disappears automatically when you’ve paid off 22 percent of your home—but you can opt out after paying off just 20 percent. You’ll want to avoid paying PMI as much as you can, so it’s an important thing to monitor to make sure you’re not paying more than you need.
Once you’ve paid down your mortgage to 78 percent of its original amount, your lender is legally required to cancel your PMI policy. At that point, you’ve crossed the threshold of a traditional down payment and are no longer considered a high-risk lender.
But here’s the even better news: if you’re paying attention to your mortgage payments and how much equity you’ve accumulated, you can say goodbye to PMI even sooner. As soon as you cross that magical 20 percent equity line, you have a legal right to request cancellation of your PMI policy—as long as you have a good mortgage payment record. The bottom line? Keep track of how much you’ve paid down. If you just wait for the automatic cancellation to kick in, you’re wasting money.
3. Recent changes in PMI.
Recent government protections have made PMI less expensive for those with good credit scores and more expensive for those with worse credit.
Why? Well, PMI has been around since 1957. The volume of PMI sold hit historic highs in the early and mid-2000s and plummeted during the housing crisis in 2008. It’s slowly rebounded since 2012, although it still hasn’t returned to pre-crisis levels.
As a result of the crisis, government-sponsored entities like Freddie Mac and Fannie Mae have instituted new rules to protect themselves and their investors against loan defaults. Those rules make things a bit easier for borrowers who have good credit and higher down payments. In recent years, PMI rates have gone down significantly for borrowers who have a credit score over 739 and a down payment over 10 percent.
There’s a flip side to that trend for those who aren’t so financially stable. Borrowers with credit scores under 700 and down payments of less than 10 percent have seen some sharp increases in PMI costs in recent years. That said, PMI is still an option for lenders who have lower credit scores or fewer savings for a down payment; it’s just going to cost as much as 50 percent more.