Whether you’re actively saving to buy a home or just see yourself becoming a homeowner in the distant future, you’ve likely heard that you should have at least 20 percent of your home price ready upfront for the down payment.
Depending on where you live, however, 20 percent can add up to a significant amount. The average new home price in the U.S. as of September 2018 was more than $377,000 — making a 20 percent down payment more than $75,000. And the hotter the real estate market, the more you’ll likely have to put down.
To get closer to that homebuying dream, many people turn to low-down-payment mortgages. But here’s something that people often gloss over in their excitement to leave the rental market: These loans can actually be *more* expensive in the long run, in part because of something known as private mortgage insurance, or PMI.
WHEN WOULD I HAVE TO PAY PMI?
When you apply for a conventional mortgage with a down payment of less than 20 percent, you’re considered a bigger risk to a lender than a homebuyer who’s able to put down more up front. To offset this risk, lenders will require you to pay PMI, which protects the lender in the event you are unable to make payments. (You read that right — although you pay PMI, it’s not insurance coverage for you, it’s for the lender’s benefit.)
There are some loan programs specifically designed to help borrowers who can only afford lower down payments or who have problems qualifying for conventional loans because of their credit score. One of the most popular is backed by the Federal Housing Administration (FHA). These FHA loans also charge for mortgage insurance, although they call theirs a mortgage insurance premium, or MIP.
HOW MUCH DOES PMI COST?
How much you’ll pay in PMI depends on a few factors, including your credit score, how much you’re putting down and your lender’s terms. Generally, though, PMI will be based on a percentage of your loan amount, typically between 0.5 percent to 1 percent, but it can also be higher. And while 1 percent may sound insignificant, it can add thousands onto the cost of your mortgage.
Typically, you’ll pay for PMI through a monthly premium that’s tacked onto your mortgage payment, although it’s possible you may pay it upfront at closing, or some combination of upfront and monthly costs. If a lender offers you various options for how you’ll pay PMI, ask them to calculate how much each method would cost you in the long run.
FHA loans, meanwhile, require two types of MIPs: One you pay upfront, called an UPMIP, which is currently set at 1.75 percent of the base loan amount; and an annual MIP that is calculated each year but paid monthly. How much you owe is based on factors like your loan term, loan amount and your loan-to-value ratio.
HOW LONG DO I HAVE TO PAY PMI?
With most conventional loans, you can request that the lender stop your PMI payments once you reach 20 percent equity in your home (meaning you’ve paid off 20 percent of the value of your home).
But for FHA loans, how long you pay the annual MIP depends on how big your down payment is, as well as the length of your loan term. If you put down less than 10 percent, however, you’ll have to pay MIP for the length of your loan term. Because of this, some people may eventually opt to refinance their FHA loans into a conventional loan, but you’d still need to have 20 percent equity in your home in order to avoid PMI.
Bottom line? Yes, saving a full 20 percent down payment can feel daunting, but it will help save you from paying PMI or MIP. Of course, it’s ultimately up to you to decide how much to put down, but it’s important to know the total cost of buying your home so you can see how other financial goals could be impacted — and feel confident you’re able to afford the home you love.