Conventional wisdom says that you must pay 20% down when purchasing a home. Like most things financial, the reality is a little more complicated than that.
Sure, putting 20% down can qualify you for a lower interest rate, lower your monthly payments, and make you more attractive to sellers, mortgage lenders and real estate agents. But coming up with 20% cash to put down is a big hurdle for many home buyers, especially first-timers.
To enable a broader range of buyers to enter the home market, private lenders and government programs offer a variety of solutions, including the often-misunderstood private mortgage insurance, or PMI.
Designed to protect the lender in the event you default on your loan, PMI is required on all government-backed FHA and USDA loans and on most conventional loans if you are putting down less than 20%. The cost for mortgage insurance varies by the type of loan, but it typically ranges from 0.5–1.5% of the loan amount per year. Say your loan is $150,000 and your annual PMI is 1.0%. Your annual PMI cost would be $1,500, or $125 per month on top of your monthly mortgage payments.
PMI is calculated yearly as a percentage of the mortgage loan amount—not the home’s value or purchase price. As you pay down your mortgage, your PMI rates will drop accordingly. When you reach 20% equity in your home, many mortgage programs will allow you to drop your coverage.
Now, no one wants to add to their monthly mortgage costs. But for many home buyers, taking on monthly PMI payments in exchange for making a lower—or no—down payment up front is a smart financial decision.
According to a recent report by the National Association of Realtors, 52% of all non-cash home buyers put down less than 20% on their purchase, as did a whopping 74% of first-time home buyers. After all, saving enough to put 20% down can be a challenge for anyone, especially in today’s hot housing market. Consequently, many would-be homeowners delay purchasing a home until they’ve saved enough for a 20% down payment. Meanwhile, home prices continue to rise, the money you’ve saved doesn’t go as far, and you’ve spent a few more years paying rent when you could have been building equity.
Should you pay for PMI or save for that 20% down payment? The answer is based on a number of factors. Your USA Mortgage banker can walk you through the ins and outs to help you determine the right choice, and find the right mortgage loan, for your unique circumstances.