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Down Payments and PMI: Get the Low Down

Homeownership | June 25, 2014

Down Payments and PMI

If you're in the market to buy a home, you've probably heard the rule of thumb that you shouldn't buy a home unless you can put down 20% to avoid paying Private Mortgage Insurance (PMI). Why is 20% the magic number and what is PMI?

It's a fact that the more you put down, the lower your monthly mortgage payment and the less you'll owe the bank.  It's also a fact that homebuyers who put down at least 20% don't have to pay Private Mortgage Insurance, an added insurance policy that protects the lender if you are unable to pay your mortgage. As the borrower, you pay the monthly PMI premiums, and the lender is the beneficiary. However, if putting down 20% will deplete all of your savings and leave you with no financial cushion, it's probably not in your best interest.

Fortunately, when it comes to the size of your down payment you have choices – and a growing number of today's buyers are putting down between 5 and 10%. Sure, you'll have to pay PMI for a conventional loan with a down payment of less than 20%, but it means you'll be able to take advantage of today's historically low mortgage rates and affordable home prices in many parts of the country. And, once you've built equity of 20% in your home, making the amount you owe on your mortgage 80% or less of its value, you can cancel your PMI and remove that added expense from your monthly payment.  For borrowers with FHA loans, you'll be responsible for paying FHA mortgage insurance premiums for the life of the loan.

The cost of PMI varies based on your loan-to-value ratio – the amount you owe on your mortgage compared to its value – and credit score, but you can expect to pay between $30 and $70 per month for every $100,000 borrowed.  It's no doubt an added cost, but it's enabling you to buy now and begin building equity versus waiting 5 to 10 years to build enough savings for a 20% down payment.

Take a look at how a $200,000 home looks with 5% down and 20% down, below, to see the impact on a monthly mortgage payment. Not surprisingly, the mortgage payment with less down will cost more – especially until you reach 20% equity in your home – but the value may be getting your foot in the door.

As for the rule of thumb about putting 20% down: Yes, you won't have to pay PMI, but remember you have plenty of choices when it comes to your down payment. Carefully evaluate your finances to determine how much you can afford and talk with your lender or housing professional about what makes best sense for you and your particular situation.

A $200,000 Home: 5% Down vs. 20% Down

 5% Down Payment20% Down Payment
Down Payment $10,000 $40,000
Loan Amount $190,000 $160,000
Mortgage Type 30-year fixed-rate 30-year fixed-rate
Interest Rate 4.5% 4.5%
Monthly Mortgage Payment (Principal and Interest) $962.70 $810.70
PMI* $80.75 $0
  $1,043.45** $810.70*

*Assuming an insurance rate of 0.51 percent; this cost can be cancelled from your payment once you reach 20% equity in your home for conventional loans, but not FHA loans

**Not including property taxes and insurance


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