You’ve been saving for months (or years!). But you’re still far short of the amount you need for the traditionally advised 20% down payment on a new house to avoid paying private mortgage insurance. When saving up for a new home, especially your first, it can feel like forever before you’re able to save the tens of thousands of dollars you’ll need.
If your budget is similar to the median US home price of $265,000, you need to amass at least $53,000 to have the 20% down payment. For most homebuyers, that amount will take a while to save.
Are there other options besides putting 20% down?
Many lenders will allow a smaller down payment of 10% or even 5%. But they require homebuyers to take out private mortgage insurance (PMI). It is insurance that the homeowner pays in exchange for a smaller down payment. This insurance protects the lender (i.e., the bank that provides you with a loan) – in case you stop making mortgage payments.
According to Investopedia, you’ll typically pay between .5% to 1% of your loan balance per year in PMI on a conventional loan. If you bought a $265,000 home with 10% down, your loan balance would be $238,500. This means you could expect to pay up to $198.75 per month ($2,385 per year) in PMI. This insurance premium is added to your monthly mortgage payment.
Once you’ve made enough payments to achieve at least 20% equity in your home (that is, you owe less than 80% of the home’s value, according to your latest appraisal), you stop paying PMI. In our example, if we assume a 30-year mortgage at 4% interest – it could take more than six years for the principal of the loan to be paid down that far. This could mean over $14,000 just in PMI payments.
Is there any other way to save on or avoid paying PMI?
There are some mortgages allowing you to pay the cost of PMI upfront, with what’s known as “single premium PMI.” This will require a more substantial initial payment. An amount anywhere from 1-2% of the loan cost. In most cases, this amount will be much less than an additional 10% down payment. You’ll also end up paying less PMI over the life of the loan.
Other negatives of having PMI
It might seem tempting to trade a cost of $200 per month or an upfront payment of several thousand dollars for getting into a home earlier. However, there are some downsides to paying PMI.
Apart from the fact that you’ll have an additional monthly cost you’ll never recoup, buying a house with less than 20% down means you’ll have a higher mortgage payment and you’ll pay more in total interest. All because your loan amount is higher.
You also run the risk of being in a negative equity situation if you have to sell your house in the next few years. Putting down 20% insulates you from fluctuations in the value of your home from year to year.
It also helps ensure you’re indeed in a financial position to buy a house. Many new home buyers get deeper into debt because they fail to budget for necessary home maintenance. This includes smaller items like tools, lawn mowers or ladders and major home expenses like painting the home, replacing appliances, or putting on a new roof.
Does it ever make sense to put less than 20% down on a house purchase?
There are plenty of reasons why people choose to buy a house with a smaller-than-20% down payment. Maybe you’ve found a terrific deal in your dream neighborhood? If you wait to save a more significant down payment, you’d lose the opportunity of a lifetime.
If you’re risk-averse, you may wish to have more cash available for an emergency fund. You could also plan to accelerate the principal mortgage payments on your home in a few months or years, wiping out your PMI fast. Or maybe you need a house now because your family is growing or you’re relocating.
Just be aware that over the life of your loan, you’ll pay not only PMI but higher amounts of interest because you took out a bigger mortgage. Meaning that your total cost can be a lot higher than “just” the cost of PMI.
What if I don’t have a 20% down payment and I want to avoid paying PMI?
There are several things you can do if you want to avoid paying PMI. One option is to take out a second mortgage. Some lenders will allow you to do this by setting up a home equity line or taking out a second loan. Be warned, though: you’ll generally pay a much higher interest rate for this second mortgage than you will for the first.
Another option is to rethink your plan. If you have less than 20% to put down, you might consider revising your budget and buying less house. While this is generally a less “fun” option, you could consider buying a fixer-upper and renovating it slowly as you save up for it.
You could also look into buying a duplex or a house with a mother-in-law suite instead of a single-family home. Then you could rent out the extra side of the house or suite within your home. This way, you could earn extra money to help you pay down your mortgage. And get rid of your PMI payments much faster than going it alone.
What makes the most sense for you?
The most important thing to remember is that personal finance is personal. Even if experts recommend putting 20% down for a home to avoid paying PMI, there may be a different option better for you. Just be honest with yourself about what you can genuinely afford before you sign on for a mortgage that will be with you for many years to come.
Article Written by Laurie