With house prices being so high, it can be difficult to save up a down payment. Traditionally, banks would require at least 20% down to get approved for a loan. With house prices being so high, banks have now started accepting down payments as low as 5%. Doing a down payment under 20% has some stipulations, the main one being you are required to pay for private mortgage insurance (PMI).
PMI stands for private mortgage insurance and is an extra fee you pay along with your mortgage when you don't have 20% of equity in the house. Lenders require PMI as a way to protect their loan. Having under 20% is seen as being a riskier loan and assessing the extra PMI fee helps banks protect their downside.
There can be heated debates about if PMI is worth paying or not. This particular post isn't going to cover the drawbacks or benefits of PMI, but more about what PMI is, how much it costs, and how long you will have to pay it. It is sufficient to say that everyone's situation is different. Sometimes it could be a decade to save up 20% for a down payment with the way house prices are. It is up to you to decide if the extra cost is worth it for you and your situation.
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A big concern with any loan is how much will it cost you per month. PMI typically costs you anywhere from .5% to 1% of the total loan amount. Specifically, this is the amount left after you subtract your down payment. To make things a bit more clear, lets run through an example of how much PMI could cost you. Let's assume we are buying a house for $275,000 but only have enough for a 5% down payment. Here is what our loan will be.
|Down Payment (5%)||$13,750|
|Total Loan Amount||$261,250|
After subtracting our down payment we have $261,250 left. To calculate PMI take our loan amount and times it by .075%. Like we said before, the range could be anywhere form .05% to 1%. For our example, we will split the difference and use .075%.
To get the yearly amount of PMI, take our loan and times it by the rate:
$261,250 x .075% = $1959.38
Then, to see how much it is monthly divide the yearly rate by 12:
$1959.38 / 12 = $163.28
For our hypothetical loan our example person will be required to pay $163.28 on top of their mortgage. As I said before, it is up to you if this fee is worth paying to be able to buy your house with less down payment.
Even though PMI can cost quite a bit, the good news is you won't have to pay it for the entire length of your loan. You only have to pay PMI as long as you have less than 20% equity in the home. After that, your PMI payment goes away and you only have to pay your regular mortgage payment. Let's stick with our original example house of $275,000.
$275,000 x 20% = $55,000
Once you have $55,000 of the house paid off you will no longer have to pay PMI. It should be noted that it's not necessarily $55,000 of total payments, but $55,000 of the actual house being paid off. Each mortgage payment has interest baked into it so your entire mortgage payment doesn't go directly to house equity.
If you increase the amount that you pay towards your house you can get rid of PMI faster. I would suggest you consider this option if you are able to. Not only will you save on PMI, you will also save on interest paid for the house. Accelerated payments are a great way to save some fees and interest, with the side benefit of paying off your house faster.
The easiest (and only) way of avoiding private mortgage insurance is to put at least 20% down when you buy a house. This is often easier said than done as the difference in what you need to save can be tens of thousands. If you can't manage 20% then you should add PMI into your calculations when looking at how much house you can afford.