Believe it or not, but you CAN purchase a home without a 20 percent down payment, you just need private mortgage insurance.
Lenders offer numerous loan programs with lower down payment requirements to fit a variety of budgets and buyer needs.
That said, one of the requirements for not paying the 20 percent down payment is paying private mortgage insurance (PMI).
This is an additional expense that can drive up your monthly payments and make your loan more expensive.
For this reason, most people like to avoid it when possible.
Read on to learn everything you need to know about PMI.
1. What is private mortgage insurance?
Private mortgage insurance — also known as PMI — is a type of insurance policy that protects the lender if a borrower defaults on a home loan.
Your lender may require PMI if you put less than 20 percent down on a conventional mortgage.
This insurance benefits your mortgage lender — not you.
You’ll pay a monthly premium to your insurer, and your coverage will pay out a portion of the balance due to the mortgage lender if you default on the home loan.
This insurance doesn’t prevent you from foreclosing or experiencing a decrease in your credit score if you get behind on mortgage payments.
If you dislike the sound of private mortgage insurance, don’t fret.
You can avoid it entirely by making a 20 percent down payment.
2. How much does PMI cost?
The cost of private mortgage insurance depends on factors like your credit score and down payment.
In general, it ranges from 0.3 percent to 1.5 percent of the original loan amount each year.
According to the Urban Institute, the average span for PMI premium rates is 0.58 percent to 1.86 percent of the original amount of your loan.
Most borrowers will pay $30 to $70 per month in PMI premiums per month for every $100,000 borrowed.
Here are the two key factors that will affect how much you pay.
Your loan-to-value (LTV) ratio:
How much you put down initially will impact how much you’ll pay for PMI.
For instance, if you put down only 5 percent, your LTV ratio will be 95 percent.
Your LTV ratio would adjust if you put down 15 percent; it would become 85 percent as a result.
When you put down a smaller down payment your lender is assuming a bigger risk.
Your PMI payments are used to account for a higher risk.
Your credit score:
Your credit history and corresponding credit score play a major role in the cost of PMI.
Your credit score is a measure used to indicate your ability to repay your loan.
Thus, someone with an excellent credit score (760) will be given a lower insurance rate than someone who has an okay credit score (620 to 640).
3. What are the different types of PMI?
Not all types of private mortgage insurance are created equal.
Here are a few different mortgage insurance options that you may consider if you need it.
Borrower-paid mortgage insurance:
This is a type of PMI in which the premiums are part of your monthly bill.
Borrower-paid PMI will include the principal balance, interest charges, and other costs (i.e., property taxes).
These funds are sent to the insurer each month with the designation “special payment” — a mere indication that the money was paid out.
Lender-paid mortgage insurance:
Don’t fall for this trap — you’re still paying for the coverage as the buyer.
However, instead of seeing the premium as a line item, you’ll pay a higher interest rate on the mortgage and/or shell out additional origination fees for the loan.
Single-premium mortgage insurance:
This option bundles the entire cost of PMI into one payment.
Depending on the terms of your loan, you’ll pay this in full at closing or roll the amount into the loan for a higher balance.
Split-premium mortgage insurance:
If you want to get a chunk of your PMI payments out of the way, this is a great choice.
In this arrangement, you’ll pay a larger upfront fee that helps to shrink your monthly payments.
FHA mortgage insurance:
This is a specific type of mortgage insurance that accompanies an FHA loan.
With this insurance, you’ll pay an upfront payment and annual mortgage insurance premiums (MIP).
In most cases, you’re unable to cancel this insurance.
4. What are the different methods of PMI payments?
The payment options for private mortgage insurance depend on your lender.
However, there are three primary schedules generally available.
Monthly:
The most common way to pay your premiums is monthly.
Although it boosts the size of your monthly bill, it permits you to spread out your premiums throughout the year, which makes it more accessible to people who are “cash poor.”
Upfront:
PMI payment can also be made upfront.
With this method, you pay the full premium amount for the year all at once.
This lowers your monthly mortgage payment, but it burdens you with a larger annual expense.
Furthermore, it may not be the smartest option for anyone planning to move within the year as it can be difficult to get an upfront payment refunded.
Hybrid:
The final option is a mix between upfront and monthly payments.
If you have some extra cash early on in the year, this choice can allow you to reduce your monthly housing costs.
To select a payment method, ask your lender.
They should be able to decide which option is best.
5. Do all lenders require PMI?
Nearly all lenders require PMI for conventional loans if the down payment is less than 20 percent.
Sometimes you’ll see lenders waive PMI for borrowers with less than 20 percent down.
However, this can also bump up your interest rate.
Don’t automatically fall for no PMI being the best option.
You must do the math to see if this type of loan makes the most sense for you and your situation.
Additionally, certain government-backed programs don’t charge mortgage insurance.
For example, VA loans don’t require it if you’re eligible.
This allows homebuyers to make purchases even if they haven’t saved up a large down payment.
Furthermore, FHA loans require their own mortgage insurance.
However, these rates can sometimes be lower than PMI.
That said, you won’t be able to cancel the insurance even after you reach the right equity threshold.
While it may seem cheaper because of the lower rate, it can end up being the more expensive option long term.
Keep in mind that your credit score doesn’t affect the insurance rate for FHA loans; although, it can be higher if you put down less than 5 percent.
6. Is private mortgage insurance tax deductible?
In 2020, the government reinstated the ability to make PMI premiums deductible from your taxes.
With that, the benefit begins to phase out after your adjusted gross income reaches $100,000.
Take the time to determine if itemizing your deductions and including your PMI is greater than the standard deduction.
7. When can you stop paying for PMI?
When your loan balance is less than 80 percent of the original appraised value or the current market value of your home — whichever is less — you can typically stop paying for PMI.
But there may be some other requirements as well, including the history of timely payments and the absence of a second mortgage.
8. Is PMI based on credit score?
Yes, your credit score impacts how much private mortgage insurance will cost you.
A borrower with a higher credit score will pay a lower monthly premium for PMI than someone with a lower credit score (with all other factors — down payments and mortgage amounts — being equal).
9. Is PMI good or bad?
If you pay private mortgage insurance, it’ll cost you some additional money each month.
With that, you’ll be able to buy a home and begin building home equity more quickly than if you waited to save up a 20 percent down payment.
10. Does PMI decrease over time?
No, it doesn’t decrease over time.
That said, if you have a conventional mortgage, you’re able to cancel PMI once your mortgage balance is equal to 80 percent of your home’s value at the time of purchase.
11. Can you avoid private mortgage insurance?
There are a few ways that you can avoid PMI without making a 20 percent down payment.
One example is known as an 80-10-10 loan (also known as a “piggyback” loan).
With this loan, you may put 10 percent down and have two mortgages that cover the other 90 percent.
This situation is uncommon, but some lenders will offer lender-paid mortgage insurance.
This scenario is not always ideal, however, as you’ll end up paying a higher interest rate to help cover the cost.
12. Can you stop paying PMI?
Yes, you can remove private mortgage insurance in a few ways.
First, build equity in your home over time.
Your mortgage servicer is legally required to stop charging PMI premiums once your balance hits 78 percent of the original loan.
This tactic doesn’t apply to FHA loans as you can only cancel FHA MIP if you put at least 10 percent down on your home and reach the 11-year mark in your repayment schedule.
Second, you should contact your servicer when you have 20 percent equity.
When your balance reaches 80 percent of the original loan, you can request to cancel your PMI.
Third, you should get your home appraised.
Simply reaching the magic 20 percent equity marker doesn’t just involve paying down your principal over time.
Contact your lender to request a professional appraisal once your home’s value has appreciated.
An appraisal will cost around $350, which can be easily recouped by cheaper mortgage payments.
Fourth, consider refinancing your mortgage.
This is another option that will include an appraisal.
Although the process costs more, it could make sense if your original mortgage had a high interest rate.
Fifth, try a piggyback mortgage.
With this loan, you’d actually get two separate mortgages.
The first loan would be for 80 percent of the home’s value and the other would be for 10 percent of the home’s value.
You’d make a 10 percent down payment from your savings and use the smaller of the two loans to complete the 20 percent down payment.
While this method helps you avoid PMI, the piggyback mortgage could mean having two loans and two monthly payments to make.
You may end up paying more in interest than you would with private mortgage insurance, so this isn’t everyone’s favorite route to take.
Finally, because piggyback loans have shorter terms than the primary mortgage, your monthly payments will be higher.
13. Is there a difference between private mortgage insurance and mortgage protection insurance (MPI)?
PMI is sold entirely for the lender’s protection.
MPI continues to cover your mortgage payments after you die.
This type of insurance can help to protect your family members from facing foreclosure on a property after you’ve passed on.
You may hear MPI referred to as “mortgage life insurance.”
14. Is mortgage insurance from FHA loans the same as PMI?
No, mortgage insurance works differently than FHA loans.
Most borrowers will find FHA loans more expensive than PMI as the latter doesn’t require you to pay the premium upfront unless you choose single-premium or split-premium insurance.
15. Should you pay off your PMI early?
It’s critical that you cancel your private mortgage insurance as soon as possible because the savings can be significant for your monthly payments.
For instance, say you had a $300,000 loan amount on a one-unit primary property for a 30-year fixed loan.
In most cases, you can request termination of the policy when you reach 20 percent equity, and the program will auto-cancel at 22 percent equity.
However, there will be a 9-month period between the time you reach 20 percent and 22 percent (when the policy auto-cancels).
If you had an insurance rate of 0.5 percent of your loan amount, your savings would be $1,125 over the 9-month period.
If you had a 1 percent mortgage insurance rate, your savings would be $2,250 over the 9-month period.
Staying on top of this can save you big bucks in the long run!
Final Thoughts
Private mortgage insurance comes with one major benefit.
When you buy it, you have the ability to buy a home without waiting to save a 20 percent down payment.
Home prices are continuing to climb, and the down payment is a real barrier for people being able to purchase their dream homes.
As of December 2022, the average home price hit an all-time high at $359,000 according to the National Association of Realtors.
In this scenario, your down payment would be a whopping $71,800.
For many first-time homebuyers, this figure isn’t attainable.
So, don’t wait to save.
Use PMI to stop renting and start buying.
Homeownership is a great tool to build long-term wealth.
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Disclaimer: we are not lawyers, accountants or financial advisors and the information in this article is for informational purposes only. This article is based on our own research and experience and we do our best to keep it accurate and up-to-date, but it may contain errors. Please be sure to consult a legal or financial professional before making any investment decisions.
Prior to starting Gokce Capital, Erika received a Bachelor of Architecture from the University of Southern California and a graduate degree in Urban Policy from Columbia University. She worked as both an architectural designer and engineer in New York before joining the New York City Department of Housing Preservation and Development.
Erika currently lives in the New York Metropolitan area with her spouse, daughter and cat. She is originally from Chicago and still considers herself a midwesterner at heart.
Erika also loves to read, write and travel (fun fact, she has visited all 50 states and more than 30 countries!). Her new book, Land Investing Mistakes: 11 True Stories You Need To Know Before Buying Land, is now available on Amazon.