If you’re planning to buy with a down payment lower than 20%, you might’ve heard of “private mortgage insurance”, or PMI. If you clicked on this article, you’re probably still not sure what PMI means and how it will affect the total cost of your mortgage. Let’s clear that up now.
What is private mortgage insurance?
To offer affordable mortgage options, lenders often require PMI for borrowers putting down less than 20%. This insurance lowers lenders’ financial risk and allows them to make homeownership an option for people without the cash for a traditional down payment.
Most borrowers choose to include PMI as part of their monthly payments; although, homeowners often have the option to pay up front instead. Some lenders also offer “lender-paid” mortgage insurance, meaning they pay for your mortgage insurance up front, and you repay them every month with a slightly higher interest rate.
Your PMI payments will automatically end when you reach 22% equity in your home or on your request at 20% equity. Keep in mind that FHA loans require a different mortgage insurance that can not be removed, so it’s often paid for the life of the loan. If you’re looking to avoid potential long-term costs of FHA mortgage insurance, the HomeReady program may be the right option for you. We’ll talk more about HomeReady further below.
How much does PMI cost?
Your PMI pricing is determined by your total loan amount and your mortgage insurance rate. Your unique rate depends on multiple factors, but here are a few to keep in mind:
- Down payment percentage: The higher your down payment, the lower your mortgage insurance payment. This works in tiers, so your PMI will be the lowest when you put 15% down, then 10%, then 5%, then 3%.
- Credit score: The higher your credit score, the lower your mortgage insurance payment. Again, this works in tiers — your PMI will be the lowest if you have a credit score above 760, and the pricing will increase with every 20-point drop in your credit score. Interested in improving your credit score? Find out how here.
- Debt-to-income (DTI) ratio: Your DTI ratio is your total monthly debt payments divided by your gross monthly income. If your DTI is above the 45% threshold, your PMI may cost significantly more. Calculate your DTI here.
- Property occupancy: When you apply for a mortgage, you’ll be asked how your property will be used. PMI will be lowest if your property is classified as a primary residence, slightly higher if it’s a second home, and highest if it’s an investment property. Learn more about the requirements for each of these property categories here.
- Number of borrowers: A borrower is anyone listed on your mortgage whose income, assets, and credit history are used to qualify for the loan. If you have more than one borrower on your mortgage, your PMI will be cheaper. That’s because lenders feel safer knowing that at least two people are responsible for the loan. See if you should add a co-borrower to your mortgage here.
Is PMI worth it?
While low down payment loans can make it easier or faster to get your dream home, you might be worried about the additional cost that comes with private mortgage insurance. So should you wait until you have that magic 20% down payment?
If you’re a renter and the only thing in your way of buying is the down payment, consider this: by the time you save enough to make that 20% down payment, there’s a good chance you’ve already spent the money you “saved” on PMI on your rent.1 There are, however, certain scenarios where it might make sense to wait to buy and lower your PMI costs.
How to save on PMI
Often, a boost to your financial profile can only slightly improve your PMI pricing. However, there are still some cases in which you may save a significant amount on mortgage insurance by improving a few of your numbers. Your credit score and DTI are two of the most influential factors of your pricing. If you have a flexible timeline, it might make sense to hold off on buying a house until you can get both of those numbers in good shape. Here are some tips for increasing your credit score, and here are some best practices to get your DTI under the 45% threshold.
Tip: Some homebuyers choose to lower their down payment percentage if it only slightly increases their PMI payment. That way, they have some spending room for the other upfront costs of buying a home, such as renovations or furnishings.
You can also save by shortening your payment period, so you can reach the 20% equity needed to remove PMI sooner. Consider shopping for homes with a lower purchase price while still using your intended down payment savings. Doing so will boost your equity relative to your home’s value, so you’ll be closer to 20% without having to save up additional down payment funds. Lowering your price range isn’t always possible, especially in competitive housing markets. Instead, you might opt to make larger monthly mortgage payments than required for your loan to build equity faster and reduce your PMI timeline.
Another way to save on mortgage insurance is through HomeReady, an affordable lending program similar to the government's FHA loan program. As mentioned earlier, HomeReady comes with cancellable private mortgage insurance, while FHA mortgage insurance is often required for the life of the loan. And if you plan on making a down payment below 10%, HomeReady will reduce the standard PMI coverage requirements, so you’ll receive better PMI pricing as well. See if you qualify for HomeReady here.
Understanding your options
Deciding if it’s the right time to buy? Planning your down payment strategy? A great way to understand your options is by exploring each scenario with a mortgage expert. They can help you understand your numbers, their impact on your PMI and overall monthly payment, and what makes the most sense for your unique circumstances. Schedule a free consultation with one of our non-commissioned Loan Consultants today for honest guidance and support.