Making a 20% down payment on a home isn鈥檛 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鈥檚 lower than 20%, you should consider the potential additional costs you鈥檒l have to pay, like private mortgage insurance. All of this mortgage lingo can make the financing process seem confusing, but it doesn鈥檛 have to be. In this article, we鈥檒l explain what private mortgage insurance is and when you need it 鈥 plus, how to avoid it.

What is Private Mortgage Insurance?

Private mortgage insurance, or PMI, is a type of insurance that you鈥檙e required to pay for some types of conventional home loans. Conventional loans are the most popular type of home loan and they鈥檙e not backed by the federal government. Lenders require PMI to protect themselves in case you end up in foreclosure. That鈥檚 why it鈥檚 typically required for buyers who make low down payments, since those loans are considered 鈥渉igher risk鈥 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鈥檛 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鈥檒l make while living in their dream home.

The downside of private mortgage insurance is that you鈥檒l have pay an added expense each month. PMI protects the lender, but it鈥檚 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鈥檛 black and white, and there鈥檚 no steadfast rule on whether PMI is good or bad鈥攊t 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鈥檛 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鈥檒l 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鈥檛 mean you鈥檒l be stuck making private mortgage insurance payments forever. Once you鈥檝e paid off 20% of the equity of your home, you can cancel your PMI. This means you鈥檒l only be making these payments for a few years.

Types of Loans that Do Not Require Mortgage Insurance

While you鈥檒l 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鈥檛 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鈥檚 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鈥檛 have to pay for mortgage insurance premiums. To get a VA loan, you must be eligible based on the VA鈥檚 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鈥檒l be able to make a lower down payment with no PMI. The second loan for 10% of the home鈥檚 purchase price will have a higher rate than your first loan. However, once the second loan is paid off, you鈥檒l just be left with a traditional conventional loan with no private mortgage insurance. With a piggyback loan, you鈥檒l 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 .

Last Updated on October 30, 2019