Did you hear that story? You know, the one about how you must have a 20% down payment to buy a home? Turns out that’s actually not the case.
In fact, for as little as 3% down, house hunters are turning into homeowners.
But there’s one caveat: If you’re looking to become a homebuyer without putting down 20%, you’ll likely need private mortgage insurance (PMI).
If this is your first time hearing about PMI, or you’re unsure what it is or how much it costs, we can help.
What is private mortgage insurance?
Lenders often require private mortgage insurance (commonly called PMI) for borrowers putting less than 20% down. This coverage gives you the ability to buy a house even if you don’t have enough cash on hand for a traditional down payment, but it also protects your lender if you fall behind in your monthly mortgage payments.
You can include PMI in your monthly mortgage payments. Or, if you prefer, you can also 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.
You can request to cancel your PMI once you have 20% equity in your home. Or your payments will end automatically once you have 22% equity.
Keep in mind: An FHA loan may require a different mortgage insurance — be sure to check the terms for whether or not it can be removed and for how long you’re responsible for paying it. A HomeReady loan, a conventional mortgage offered by Fannie Mae and available from Ally Home, doesn’t require a 20% down payment and could give you the ability to avoid this long-term cost. Similarly, Freddie Mac’s Home Possible program offers mortgages for as little as 3% down, and PMI is cancellable after the loan balance drops below 80% of the home’s purchase price.
Pro tip: Private mortgage insurance and homeowners insurance are two different things. PMI covers your lender if you default on your mortgage, and homeowner’s insurance covers your house and its belongings in case of a disaster, like a fire or hail storm.
How much does PMI cost?
How much PMI will cost depends on your total loan amount and your mortgage insurance rate. Your unique rate depends on multiple factors, including:
Down payment percentage: The larger your down payment, the lower your mortgage insurance payment. PMI has tiered pricing, so it’ll be the most affordable 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 cheapest if you have a credit score above 760, and the pricing will increase with every 20-point drop in your credit score. (If your score needs a boost, these tips can help you.)
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.
Property occupancy: When you apply for a mortgage, you’ll be asked how your property will be used. Your 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.
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.
A low down payment loan can make it easier or faster to get your dream home, but 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. But each person’s financial situation is unique, and there may be certain scenarios where it makes sense to wait to buy and avoid the expense of PMI.
How can you reduce the cost of PMI?
In some instances, a boost to your financial profile will only slightly improve your PMI pricing. But it is possible to save a significant amount on mortgage insurance by improving a few of your numbers.
Improve your credit score and/or DTI, since they 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.
Shop for more affordable homes without changing your intended down payment amount. Doing so will boost your equity relative to your home’s value, so you’ll be closer to 20% without saving more for your down payment. It will also reduce your loan-to-value ratio (LTV), which is the amount you’ve borrowed by the purchase price of the property. Lenders will offer you the lowest rates when your LTV is at 80% or lower.
If lowering your price range isn’t possible, (especially if you’re looking in a competitive housing market), opt for making larger monthly mortgage payments, so you can reach the 20% equity needed to cancel PMI sooner. Or you can make additional payments and apply them directly to your principle, which also helps you reach that magic 20% equity faster.
Consider HomeReady, an affordable lending program similar to the government's FHA loan program. As mentioned earlier, HomeReady comes with cancellable private mortgage insurance. 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.
Pro tip: Some homebuyers choose to lower their down payment percentage if it only slightly increases their PMI payment. That way, they have cash available for the other upfront costs of buying a home, such as renovations or furnishings.
How to avoid PMI
A 20% down payment is the most common way to avoid PMI, but what if you don’t have that kind of cash on hand? Luckily, you have several creative alternatives.
While it might not feel like the most comfortable option, asking for gift money could you help increase your down payment. If you plan to get married in the near future or the holidays are coming up, consider forgoing traditional gifts for cash instead.
You may also consider a co-investment program like Unison’s HomeBuyer, which assists you in making a 20% down payment in exchange for a portion of your home’s appreciation when you sell in the future.
Another potential option is to take out a second mortgage (a “piggyback” mortgage) at the same time as your first. This can help keep your loan-to-value (LTV) ratio under 80% to avoid the need for a PMI. However, keep in mind a piggyback mortgage usually comes with a higher rate and may be harder to refinance in the future.
Understand your options
Deciding if it’s the right time to buy? Planning your down payment strategy? Even though you’ve always heard that you need to make a 20% down payment, that’s no longer true.
A great way to understand your options is to explore each scenario with our loan experts. They can help you understand how PMI could allow you to buy a home sooner than you expected, how your financial numbers could affect its cost, and what makes the most sense for your unique circumstances.