Understanding PMI and Down Payment Strategies

What is PMI (Private Mortgage Insurance)?

PMI is insurance that protects the lender if you default on your loan. It's typically required on conventional loans when your down payment is less than 20% of the home's purchase price. Unlike homeowners insurance (which protects you), PMI only protects the lender - but you pay for it.

How Much Does PMI Cost?

PMI typically costs 0.5% to 1.5% of the original loan amount per year, paid monthly. The exact cost depends on your credit score, down payment amount, and loan type.

Example: $250,000 Loan

• Low PMI (0.5%): $1,250/year = $104/month
• Average PMI (1%): $2,500/year = $208/month
• High PMI (1.5%): $3,750/year = $312/month

Over the life of a 30-year mortgage (until you reach 20% equity), this adds up to $12,000-$37,000+ in total!

How to Avoid PMI

• Make a 20% down payment: The most straightforward way - no PMI required
• Use an 80-10-10 loan (Piggyback loan): 80% first mortgage + 10% second mortgage + 10% down = no PMI
• Choose a VA loan: If eligible, VA loans never require PMI
• Lender-paid PMI (LPMI): Accept a slightly higher interest rate instead of monthly PMI
• USDA loan: 0% down for rural properties, different type of insurance

How to Remove PMI

• Request removal at 20% equity: Contact your lender and request PMI cancellation (may need new appraisal)
• Automatic removal at 22% equity: PMI automatically cancels at 78% loan-to-value (22% equity)
• Refinance when you have 20% equity: Refinance to remove PMI and possibly get a better rate
• Make extra principal payments: Accelerate reaching 20% equity faster
• Home value appreciation: If your home increases in value, you may reach 20% equity sooner

By law: Your lender must automatically cancel PMI when your principal balance reaches 78% of the original home value, as long as you're current on payments.

Down Payment Strategies

Your down payment significantly impacts your mortgage terms, monthly payment, and total interest paid. Understanding your options helps you make the best decision for your financial situation.

Traditional 20% Down Payment

The gold standard that avoids PMI, shows financial stability to lenders, results in lower interest rates, and builds immediate equity.

Example: $300,000 Home

• 20% down: $60,000
• Loan amount: $240,000
• No PMI required
• Lower interest rate (saves ~0.25-0.5%)
• Monthly payment: ~$1,517 (at 6.5%)

Low Down Payment Options

• Conventional loans: As low as 3% for first-time buyers
• FHA loans: 3.5% down with credit score 580+
• VA loans: 0% down for eligible veterans
• USDA loans: 0% down for rural properties

Example: 5% Down vs. 20% Down on $300,000 Home

5% Down:

• Down payment: $15,000
• Loan: $285,000
• PMI: ~$190/month
• Monthly payment: ~$1,991 (6.75% rate + PMI)
• Keep $45,000 in savings vs. 20% down

20% Down:

• Down payment: $60,000
• Loan: $240,000
• No PMI
• Monthly payment: ~$1,517 (6.5% rate, no PMI)
• Save $474/month vs. 5% down
• Save ~$85,000 in interest over 30 years

Down Payment Assistance Programs

Many states and localities offer grants or low-interest loans for down payments. First-time homebuyers should research local programs through:

• State housing finance agencies
• County/city housing departments
• Non-profit organizations (NACA, Habitat for Humanity)
• Employer assistance programs
• Union programs for members

Gift Money for Down Payment

Most loan types allow gift funds from family members:

• Donor must be family member (parent, grandparent, sibling)
• Gift letter required stating money is a gift, not a loan
• Documentation of fund transfer required
• FHA, VA, and conventional loans all allow gifts
• Conventional may require some of your own funds (typically 5%)

Balancing Down Payment vs. Other Goals

While larger down payments reduce your loan amount and monthly payment, consider:

• Emergency fund: Keep 3-6 months of expenses even after down payment
• Home repairs/improvements: New homes often need immediate repairs or updates
• Moving costs: Movers, utility deposits, furniture
• Closing costs: 2-5% of purchase price
• Opportunity cost: Could you earn more investing the extra down payment?

Rule of thumb: Have 3-6 months of expenses in emergency fund AFTER your down payment and closing costs.

PMI vs. Larger Down Payment: What's Better?

Consider PMI with Smaller Down Payment if:

• You can invest the extra down payment at >7-8% return
• You need liquidity for emergencies or opportunities
• Home values are rising quickly (building equity through appreciation)
• You plan to make extra principal payments to remove PMI quickly
• You're young and want to preserve cash

Go for 20% Down to Avoid PMI if:

• You hate the idea of paying for insurance that doesn't benefit you
• You want the lowest possible monthly payment
• You want guaranteed "return" (PMI savings)
• You still have 6+ months emergency fund after down payment
• Lower rates for 20% down save significant money