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A down payment on a home is likely one of the largest transactions you will ever make. While the standard rule of thumb is to pay 20% as a down payment, Americans have recently begun to pay less upfront. In 2021, the National Association of Realtors found the average down payment was 12%, while for homebuyers ages 30 and under, it was just 6%.
Typically, when you purchase a home with a conventional mortgage and pay less than 20% of the asking price as a down payment, you will have to pay for private mortgage insurance, commonly referred to as PMI. As you continue to pay down your mortgage, you can opt to have the PMI removed, which can help to decrease your monthly mortgage payment.
Below, Select details what you need to know about private mortgage insurance, how it affects your monthly mortgage payments and ways to have it removed.
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Private mortgage insurance (PMI) acts as an insurance policy for the lender in case a homeowner, for whatever reason, stops paying their mortgage. While this added cost is disclosed to homebuyers in the loan estimate and closing disclosure documents, it's hard to pinpoint how much a PMI policy will actually cost as, according to Experian, it can vary anywhere from 0.2% to 2% of the loan amount per year.
I purchased a home in January and opted to pay 5% as my down payment — my PMI is roughly $90 per month and is simply added to my monthly mortgage payment.
Chase Bank, Ally Bank, PNC Bank and SoFi ranked as some of the best mortgage lenders by Select, allowing borrowers the ability to put down as little as 3% for a home (although you may have to pay PMI if you choose to do so).
According to the Consumer Financial Protection Bureau, there are several ways you can choose to pay your private mortgage insurance:
- In the form of a monthly payment, meaning each month you will have the cost of your PMI added to your usual mortgage payment
- As an up-front premium, meaning you'll pay the entire cost of the insurance upfront, though there is always a risk you may not be able to recover the unused premium if you decide to move or sell
- A combination of both monthly payment and up-front premium, meaning you'll pay a portion of it upfront at closing, which will reduce your monthly payments for the rest of it
Keep in mind that there are exceptions to the rule, as you're not required to have PMI if you pay less than 20% as a down payment. Some lenders offer mortgage products that don't require private mortgage insurance, though you will likely have to pay more in interest costs.
If you do decide to put less than 20% down and opt for PMI, here are three ways to get it taken off and reduce your overall costs.
1. Pay down your mortgage enough
Many lenders will simply cancel your PMI payments after you reach a certain milestone in paying down your mortgage, usually around the 20% mark. This is typically a manual process, however, so be sure to contact your servicer to see what the requirements are.
Also keep in mind that if your home is 22% paid off, the Homeowners Protection Act requires the lender to cancel the private mortgage insurance without any effort on your end.
2. Refinance your mortgage
Refinancing your mortgage can save you money on interest paid to your lender as well as lower your monthly mortgage payment. It turns out you can also refinance your way out of paying your PMI.
Note that this typically only works for seasoned homeowners as many lenders will not refinance homes when the loan is less than two years old.
If you're considering refinancing, don't forget that you'll be on the hook for closing costs — do the math on your savings and see what it will actually cost to refinance your home.
3. Get your home reappraised
Housing prices have skyrocketed in the last few years, so if you purchased a home more than two years ago, it may be worth significantly more than what you paid for it — and that increase in value can help you eliminate your PMI.
For example, if you bought a $400,000 home last year with 10% down, your initial debt was $360,000. But if the home has appreciated to $450,000 and you owe $350,000, you are officially above the 20% mark. Be aware that there are associated costs with getting your home reappraised, so make sure you look into and weigh the costs if you decide to do it.
It can be a smart strategy to put down less than 20% as a down payment on your home, especially if you have a low-interest mortgage. Doing so, however, comes at the cost of tacking on private mortgage insurance.
As you begin the closing process on your home, it's extremely important to look at both the loan estimate and closing disclosure documents to ensure your home payment is affordable and within your budget.