2018 is still looks like a good time to buy a home with less than a 20% down payment. More than ever in the last several years, mortgage lenders are offering low down payment loans, with loan approval rates markedly higher than 2010.
For buyers who have less than 20% to put down, though, you need to think about private mortgage insurance or PMI. In most cases, PMI is required on all conventional loans with less than 20% down. PMI is a required insurance policy for conventional loans that insures the mortgage lender against loss if you default.
PMI differs from the mortgage insurance needed on other loans, such as FHA mortgages. Mortgage insurance on FHA loans can be costly as the premiums are higher than Fannie Mae and Freddie Mac. There also is a separate mortgage insurance program for USDA home financing.
Many Americans hate the idea of paying PMI. But is PMI good or bad? It is neither, really. Mortgage insurance IS an extra monthly cost, but it helps millions of people qualify for a loan years before they otherwise could. Only a small percentage of Americans can afford to put 20% down on a home, and it is even smaller for first time home-buyers. Let’s consider both sides, the home loan that requires mortgage insurance and the no PMI mortgage.
Should you ever get PMI with a mortgage? There are cases where it does make sense to choose a home loan with mortgage insurance.
When PMI Is Required
PMI is needed when the buyer puts less than 20% down on a conventional loan. Conventional loans are backed by Freddie Mac or Fannie Mae and are available through major home lenders such as Wells Fargo, Bank of America and JPMorgan Chase, etc.
To understand why PMI is needed on a loan with less than 20% down, it helps to review the mortgage default situation. The homeowner is not making payments on the home, and at least three payments were missed. This is creating a big loss for the lender. But state laws often delay when the homeowner can be evicted. It might be one or two years before the home can be reclaimed. During this period, the home could have damage, such as neglect, fire or flood. It probably is showing the effect of poor maintenance.
When the home is sold in a foreclosure auction, it probably means the lender has a big loss on its hands. On average, lenders lose about 20% of the value of the property during the default and foreclosure. So that is why it is a requirement to put down 20% to avoid PMI. Anything less than 20% down is a risk to the lender. PMI protects them against that loss.
Types of Private Mortgage Insurance (PMI)
There are three major options for paying for PMI. The first is the single premium option that means you are paying a lump sum when you close the loan. This will cover the cost of PMI for the entirety of the mortgage.
The second option is lender paid mortgage insurance or LPMI. This does not require you to make monthly insurance payments but your rate will be increased by the lender to cover the risk.
The third option is monthly premium PMI which is how most of us pay for it. The annual cost of your PMI policy is split into 12 payments and collected monthly.
All of these options have advantages. If you plan to stay in your current loan for a long time and expect home prices to stay flat or go up moderately, you may want to opt for the single premium plan. But if you want to move or refinance in a few years, you may want LPMI. This means you are only paying the slightly higher rate for a limited period.
For most buyers, monthly PMI is probably the best bet. Payments are monthly and will cancel once you reach 20% equity through payments and/or appreciation.
A lot of buyers think PMI is stupid and a waste of money. But it lets you buy the home with much less than 20% down. Do you have other things you could do with that money? Most people do. You could use some of that money to pay for repairs on the home, keep an emergency fund or put into investments. Access to PMI lets more people buy homes, and in particular, lowers entry barriers for the first-time homebuyer who has no equity.
PMI does add to your monthly payment, but that is ok for most people. They can afford PMI payments; what they cannot often afford is a 20% down payment.
Plus, once you have paid down the balance to 78% of the home’s original purchase price, you can have the PMI cancelled automatically by law. You also can ask the lender to cancel it once you reach 20% equity, but they may wait until 22% equity.
To qualify for PMI cancellation, you have to have made your payments on time. Otherwise, the lender may balk at cancelling PMI.
Overall, getting a mortgage with PMI makes sense for people who would struggle or find impossible putting 20% down on a home, especially first-time buyers.