Home Financing: PMI and Down Payments

Part of buying a home is researching the market and your finances. Most lenders require you to put at least 20 percent down or pay private mortgage insurance (PMI). Since PMI is a cost that does not lower your interest rate or principal, it’s almost always better to save up that hefty down payment. Lenders charge PMI to cover some of their risk if you do not put the 20 percent down to create equity. Conventional loans backed by Fannie Mae and Freddie Mac always require PMI if you do not put 20 percent down.

Avoiding PMI

Sometimes, you could avoid PMI by taking out a special loan or a VA loan. VA loans are only available to veterans, but require very little down or even zero down. The VA doesn’t actually give you the loan—it insures your loan against default. Conventional loans not backed by Fannie Mae or Freddie Mac often have higher interest rates. These two programs are also government-insured loans.

Other reasons to avoid paying PMI include:

• Tax laws change every year. As of 2017, PMI was no longer deductible, so you lose that offset.

• The lender is the only beneficiary. If you pass before your loan is paid off, it will pay only the lender and only for the balance on the home.

• You pay PMI until the equity on your home reaches 20 percent. If the market was good when you bought the home, but it tanks a couple of years later, you could be stuck paying PMI for many years.

• Some lenders require you to pay PMI even after the equity in your home reaches 20 percent. If you take PMI, always read the fine print.

• Finally, PMI is difficult to cancel. You will need to write a letter to your lender to cancel the PMI. Until you hear from the lender, you will be stuck paying those premiums every month.

• PMI ranges from .5 percent to 1 percent of the amount you borrowed paid out in equal monthly payments every year. Thus, a loan amount of $200,000 could have a $2,000 per year PMI premium, which is about $167 per month added to your mortgage payment until the lender agrees to cancel the premiums.

Saving the Down Payment

In addition to saving for a down payment, you may qualify for some down payment assistance programs such as the first-time homebuyer’s program. These programs help you get that 20 percent so that you do not have to pay PMI. If you have a retirement account, you may use money from that account to help with a down payment.

Though it may seem painful to pay such a sizable chunk of money, it saves you from paying insurance premiums and it lowers the cost of the loan since you don’t pay interest on the down payment, and it applies to the principal.