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 0.58% to 1.68% of the original loan amount, depending on factors such as your credit score, loan term, and down payment. 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’re paying every single month until you prove you’re less risky to lend to.

Why Do Lenders Require PMI?
PMI is not insurance that protects you. Instead, 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 see you as more likely not to be able to repay them (or to choose not to), because you have less of your own money on the line. PMI is their way of protecting themselves.

During the bubble leading up to 2008, many buyers purchased homes with 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%, there are many loan programs that let you put down as little as 3%, especially for first-time homebuyers. But these loans almost always come with PMI attached.

Do You Have to Pay PMI?
The simplest way to avoid paying PMI is by putting at least 20% down. This is the most straightforward way to dodge PMI. 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 hit 22% equity, your lender is required to drop it automatically, as long as you’re current on your payments. So as soon as you’re close to reaching that 20% equity threshold, you might want to throw some extra cash toward your mortgage to speed up the process and ditch that PMI fee sooner.

Should You Stretch Your Budget to Avoid 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 gets you into a home sooner. If you’ve found the right place, you’re ready financially (and emotionally), and you can afford all your monthly costs, including PMI, then 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 set aside money for home repairs and the 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 Homebuyers?
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!