When private mortgage insurance is worth it
For most people, saving up for a down payment on a residence is the most difficult part about buying a home. You'll have to scrimp and save, usually for several years, until you have enough to purchase a property.
This difficulty is further compounded by the widespread misconception that a buyer needs to have 20 percent of the purchase price on hand before they can buy a home. In reality, it's possible to buy a home without paying for one-fifth of its price at the outset. However, this will also result in the added cost of private mortgage insurance.
Private mortgage insurance is required for certain home purchases, typically those where the buyer makes a down payment of less than 20 percent. This insurance is meant as a form of protection to the lender. Since buyers with lower down payments will have less equity in the property, they are at greater risk of being underwater on a loan if the home's value drops. Private mortgage insurance helps reimburse the lender if the borrower defaults on their mortgage.
The cost of the insurance is passed on to the buyer, who pays it in monthly increments. Jaymi Naciri, writing for Realty Times, says private mortgage insurance usually adds about $30 to $70 per $100,000 balance on the mortgage.
Naturally, buyers won't be keen to pay this extra fee each month, and are often urged to put down at least 20 percent of the purchase price if possible. But it may be worth it to consider making a more modest down payment and shouldering the costs of private mortgage insurance for some time.
The key benefit to making a smaller payment is that you'll be able to keep more money in the bank. Kali Hawlk, writing for the home purchase financing company Unison, says this will free up money for other expenses, including closing costs, moving expenses, and any repairs or renovations that need to be completed as soon as possible.
Saving up for a 20 percent down payment can take a long time, especially in markets with high home prices. Aceltis Financial Group of Bloomfield, N.J., says making a smaller down payment and making private mortgage insurance payments allows you to own a home sooner. This lets you to get ahead of rising home prices and mortgage rates, which can result in an even longer saving period. It also allows you to start immediately building equity in the home through regular mortgage payments.
In some cases, you might be able to deduct private mortgage insurance costs on your taxes. Leann Harms, writing for the budgeting site The Nest, says that by itemizing your deductions, you can deduct the premiums on what you pay for this insurance.
Private mortgage insurance is temporary. Naciri says the borrower no longer needs to make these payments when your equity in the home reaches 20 percent, and the lender automatically eliminates private mortgage insurance when you have 22 percent equity in the home. By keeping track of your equity, you can ask the lender to drop the monthly fees as soon as possible; if an appraisal shows that your home value has appreciated, boosting your equity, you can eliminate private mortgage insurance much sooner than expected.
The major downside to paying for private mortgage insurance is that you'll be paying an extra fee each month. Harms says the cost of these premiums can be anywhere from half a percent to 1 percent of the loan amount, which can add hundreds if not thousands of dollars in expenses each year. These payments—combined with the mortgage principal and interest, homeowners insurance, and other expenses—can easily strain your budget.
One option is to search for loan arrangements that allow you to make a smaller down payment while minimizing or eliminating private mortgage insurance. Rachel Witkowski, writing for the financial site Bankrate, says a loan with lender-paid mortgage insurance eliminates the premiums in exchange for a slightly higher interest rate. Of course, this can lead to considerable costs over the life of the loan and slow down your ability to build up equity in the property.
Piggyback mortgages will also let you avoid private mortgage insurance if you can collect enough money for a modest down payment. Naciri says that in this arrangement, a buyer puts down 10 percent of the purchase price and takes out two loans, one to cover the bulk of the mortgage and the other to cover an additional 10 percent of the down payment.
Veterans Administration loans do not require private mortgage insurance, even if you can't come up with a 20 percent down payment. USDA loans also have relaxed down payment requirements, including a very low rate for private mortgage insurance.
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