Picture it: You’ve been working diligently on saving for your new home, and you’ve found the home of your dreams, but no matter what you do, your savings still won’t add up to the 20% down payment you need. It’s a terrifying idea, that you won’t get your fabulous home because you’re just a little short on the down payment. Rest easy, friend! So long as your hard work also went to keeping your credit score super healthy, you might have another option.
Many lenders do want that 20% down payment, it’s true. However, if your credit is good, they may work with you and allow a smaller down payment, with the caveat that you will need to carry Private Mortgage Insurance, or PMI. PMI protects the mortgage lenders in case you default on your payment. It does cost you a little more, but it allows borrowers like yourself to get a mortgage without the full down payment.
The cost of PMI will depend on the size of the down payment you are able to make and the terms of the loan itself, and will likely be between 0.5% and 1% of the loan amount. For instance, if your loan amount is $200,000 and you can manage a $20,000 down payment (which is 10% of the loan), and you are able to get a PMI rate of 0.5%, your annual PMI would be about $900, or an extra $75 a month on your mortgage payment. The math: $200,000 – $20,000 = $180,000; $180,000 x .005 = $900.
There are a few ways to get out of having PMI, or to get rid of it afterward. One is if the value of your home increases; the borrower will have to submit a new appraisal to the lender and prove that the property value has increased to at least 80% of the loan-to-value ratio. That can be done by remodeling or making other home improvements. Another option is to pay more in interest, usually between 0.75% and 1%, depending on how much of a down payment is made. This option is particularly interesting, as mortgage interest payments are tax deductible. A third option is a piggyback loan, a smaller mortgage that closes at the same time as the main one. These are also tax deductible, and may have a lower payment than the PMI on a single, larger mortgage. One last option is to know that you have the right under the Homeowner Protection Act of 1998 to request your PMI be cancelled if you have been current in your payments, and have reached home equity of at least 20%. Lenders are also required to cancel PMI if borrowers are current and have reached at least 78% of the property value. All good things to know!
So even if you can’t quite scrape up the ideal 20% down payment for your dream home, you should talk with your lending professional about your options and see if Private Mortgage Insurance, or one of the other options, are right for your situation.