PMI or a Larger Down Payment: Four Considerations

June 7th, 2018 | First-time Homebuyers

Years ago, a 20% down payment was a requirement for obtaining a mortgage loan. Putting that much money down made it less likely that borrowers would simply default on their home loans and gave lenders a measure of security and collateral in the case of foreclosure.

However, in more recent years, lenders have gotten much more creative in financing to help more Americans become homeowners. There are now mortgage loans that require as little as 3% down up front. In order to compensate for that added risk of loss, lenders require and borrowers with a down payment of less than 20% to pay for private mortgage insurance (PMI).

Private mortgage insurance protects the lender if a borrower defaults. It can apply to a conventional loan with a down payment below 20%; it is different from the insurance or fees attached to other loan programs. Compare the premium in the written offer with the cash needed for a larger down payment.

If you are in the market for a home loan but are not sure you can scrape together a large enough down payment to avoid PMI, here are 4 reasons you should think about saving a little longer:

1. Cash remaining after closing – Compare the extra down payment with reserves and other planned expenses before using all available savings.
2. Higher Mortgage Payment – PMI usually gets rolled into your total monthly mortgage payment. PMI premiums range between 0.5% and 1% of the home loan amount annually. That can add up to a couple extra hundred dollars a month that you’ll have to pay for an indeterminate amount of time.
3. Cancellation is not based simply on current market equity. Review the original-value milestones and the conditions for your covered loan with the servicer.
4. Lost Investment Opportunities – If it ends up taking years for you to earn 20% equity in your property that will mean years of having given up money to an insurance company when you could have been investing that cash for your own benefit.

Of course, there may be some situations when paying PMI makes sense. Most often this is when you are buying in an area with strong home price appreciation or if your down payment is very close to 20% and you know you will be able to put down the rest soon. And first-time homebuyers often find PMI worth the cost in order to break into the housing market.

A larger down payment can avoid conventional PMI, while a smaller one may let a buyer keep more cash available or purchase sooner. Compare the actual premium, payment, cash remaining, and the time needed to save; neither choice is automatically best for every borrower.