In Focus – SCCCU Blog

Private mortgage insurance, or PMI, is an insurance policy your lender might require you to pay if your down payment is less than 20% of the home’s purchase price. PMI typically costs anywhere from 0.58% to 1.68% of the original loan amount, depending on factors like your credit score, your loan term, and how much money you put down. That cost is usually rolled into your monthly mortgage payment. It’s not a one-time thing — in fact, it sticks around until you’ve paid down your loan enough to reach 20% equity in your home.

In other words, PMI is like an extra fee you pay every month until you prove you’re less risky to lend to.

Why Do Lenders Require PMI?
PMI is not insurance that protects you — it’s insurance that protects the lender, in case you default on your loan. It all comes down to risk. When you put down less than 20%, lenders view you as less likely to be able to (or choose to) repay them, because you have less of your own money at stake. PMI is their way of protecting themselves.

During the bubble leading up to 2008, many buyers purchased homes with little to no down payment. When home values dropped, millions of homeowners (at one point an estimated 40% of homeowners) found themselves owing more than their homes were worth — that’s what’s called being “underwater” on a mortgage. That led to a surge in foreclosures. Lenders tightened up their underwriting standards and have been more cautious ever since.

That said, while the average down payment on a home with a conventional mortgage today is around 15%, many loan programs let you put down as little as 3%, especially for first-time homebuyers. But these loans almost always come with PMI attached.

Do I Have to Pay PMI?
The simplest way to avoid paying PMI is to put down at least 20% of the purchase price. If the home costs $300,000, for example, then you’d need $60,000 down to avoid it. Yes, that’s a lot of money — but if you can swing it, it will save you a substantial amount over time.

Can You Get Rid of PMI?
Yes! PMI was never meant to last forever. Once you’ve paid off enough of your loan to have 20% equity in your home, you can typically request that the PMI be removed. And once you reach 22% equity, your lender is required to automatically drop it, as long as you’re current on your payments. As soon as you’re close to reaching the 20% equity threshold, you may want to consider allocating some extra funds towards your mortgage to expedite the process and eliminate the PMI fee sooner.

Should You Stretch Your Budget to Avoid Private Mortgage Insurance (PMI)?
Here’s where things get personal. Some people are absolutely determined to avoid PMI because it feels like throwing money away.
In many cases, PMI can be a perfectly reasonable tradeoff if it allows you to purchase a home sooner. If you’ve found the right place, you’re ready financially (and emotionally), and can afford all your monthly costs, including PMI, it may be worth it.

But be honest with yourself. If you can’t afford to put down 20% and are really stretching to qualify for a loan, you may be trying to buy too much house. Between the monthly mortgage payment, property taxes, PMI, and maintenance costs, you could end up house-poor. And that’s not where you want to be.

Remember, in addition to your down payment, you should also set aside money for home repairs and those unexpected curveballs that come with ownership. It’s smart to keep at least six months’ worth of expenses in an emergency fund. That way, if your income drops, you’re not scrambling.

What About First-Time Home Buyers?
If you’re a first-time buyer, saving aggressively for a down payment is one of the best things you can do for your financial future. PMI isn’t evil — but it is an extra cost, and if you can avoid it, you’ll free up more room in your budget for everything else that comes with homeownership. A larger down payment gives you options: You can either buy a bigger home or lock in a smaller monthly payment. Both are wins!