Making a 20% down payment on a home isn’t feasible for a lot of buyers. Luckily, many mortgage lenders now offer loan options that have more flexible down payment and credit requirements, and some of these home loans allow you to make a down payment as low as 3%. These can be great options, especially for first-time homebuyers.
But before you make a down payment that’s lower than 20%, you should consider the potential additional costs you’ll have to pay, like private mortgage insurance. All of this mortgage lingo can make the financing process seem confusing, but it doesn’t have to be. In this article, we’ll explain what private mortgage insurance is and when you need it — plus, how to avoid it.
What is Private Mortgage Insurance?
Private mortgage insurance, or PMI, is a type of insurance that you’re required to pay for some types of conventional home loans. Conventional loans are the most popular type of home loan and they’re not backed by the federal government. Lenders require PMI to protect themselves in case you end up in foreclosure. That’s why it’s typically required for buyers who make low down payments, since those loans are considered “higher risk” for the lender.
The Pros and Cons of Private Mortgage Insurance
Private mortgage insurance can actually be beneficial for buyers because it allows you the flexibility to make a lower and more affordable down payment. Without this flexibility, many buyers wouldn’t be able to qualify for a mortgage and enjoy the benefits of homeownership. Some people believe the extra cost of PMI is a small price to pay for the lifelong memories they’ll make while living in their dream home.
The downside of private mortgage insurance is that you’ll have pay an added expense each month. PMI protects the lender, but it’s an added burden on the borrower. The cost of private mortgage insurance varies by buyer, but it typically depends on your credit score and loan amount. Generally, the cost will range from $30 to $70 per month for every $100,000 borrowed.
For some buyers, the benefits of being able to afford a home make the cost of PMI worth it. For others, the additional monthly cost is too expensive, and they would prefer to continue to save up and eventually make a higher down payment down the road. Financing your home isn’t black and white, and there’s no steadfast rule on whether PMI is good or bad—it all depends on your individual needs and budget. Deciding whether you should make a lower down payment and pay for PMI depends on your financial circumstances and what payment plan best fits your lifestyle.
When Do You Need Private Mortgage Insurance?
Typically, if you have a conventional loan with a down payment lower than ten percent, your lender will require you to have private mortgage insurance. With government-backed loans, you won’t be required to pay private mortgage insurance, but you might be required to pay another type of mortgage insurance. For example, FHA loans require and upfront mortgage insurance premium and an annual premium which you’ll pay monthly.
How Can You Avoid Private Mortgage Insurance?
The easiest way to avoid PMI is to make a 20% down payment on your home. But if you make a lower down payment, this doesn’t mean you’ll be stuck making private mortgage insurance payments forever. Once you’ve paid off 20% of the equity of your home, you can cancel your PMI. This means you’ll only be making these payments for a few years.
Types of Loans that Do Not Require Mortgage Insurance
While you’ll typically have to pay mortgage insurance on any loan with a low down payment, there are a few exceptions. Some lenders will waive private mortgage insurance costs for strong applicants with very high credit scores, even if they don’t make a 20% down payment. Other loans are designed to allow buyers to make a lower down payment and avoid mortgage insurance expenses.
- USDA Loans
A USDA loan is designed to provide an affordable path to home ownership for low-to-moderate income buyers in eligible rural areas. Getting a USDA loan requires no down payment or cash savings. There are flexible credit and qualifying guidelines and no PMI. To get a USDA loan, you must live in and have an income within the required range for your area. Generally, your income must be at or below 115% of the area’s median household income.
- Veterans Affairs Loans
The U.S. Department of Veterans Affairs offers a home loan guarantee benefit to help servicemembers, veterans, and eligible surviving spouses become homeowners. There are options for fixed or adjustable interest rates, with a maximum 30-year term. VA Home loans are provided by private lenders, but guaranteed by the VA. This type of home loan enables lenders to offer more favorable terms and competitive interest rates to buyers. For example, no down payment is required up to $484,350, and you won’t have to pay for mortgage insurance premiums. To get a VA loan, you must be eligible based on the VA’s requirements for length of service commitment, duty status and character of service. VA home loans also require you to pay or finance a funding fee.
- 80% Conventional Loan with 10% Piggyback Loan and 10% Down Payment
With this type of home loan, you’ll be able to make a lower down payment with no PMI. The second loan for 10% of the home’s purchase price will have a higher rate than your first loan. However, once the second loan is paid off, you’ll just be left with a traditional conventional loan with no private mortgage insurance. With a piggyback loan, you’ll benefit from having a lower down payment, while avoiding the cost of private mortgage insurance.
There are so many different loans available these days, that the process can seem overwhelming. A good way to start the financing process is by contacting a lender to learn more about what options are the best fit for you and get advice from an expert. To learn more about loan options and what down payment is right for you, contact K. Hovnanian ® American Mortgage.