PMI is obtained at closing for a small monthly cost that is removed once you pay the loan balance down to 80% of the original value.   Alternatively, the lender can pay PMI by providing a slightly higher interest rate at the time of purchase.

Consider the average cost of homes in your area and then calculate the time needed to come up with 20% for a down payment.  It could take a long time, couldn’t it?  This is where PMI is most beneficial.  It bridges the gap between what you have already saved for a down payment and that big 20% down payment sometime in the future.

Trying to time the market or hoping for an interest rate decline is a huge gamble. As soon as you are financially able to buy a home, consider buying a home to start building equity and future wealth. If rates do decline in future, refinance to a lower rate if it makes sense financially.   

The important thing is to get your foot in the door in real estate. Most do not buy their dream home on the first home purchase.  Start small, build equity and appreciation, then sell and move up to something bigger. 

Is PMI costly?  It certainly can be depending on your down payment, mortgage loan type and credit score.  

Conventional Lending Options

This table provides the approximate cost of borrower paid monthly PMI for conventional loans assuming you a buying a primary residence.  

**Numbers below reflect a percentage of the loan amount annually, with FICO score over 740:

For example, if you buy a $400,000 home and put down 10% ($40,000), then 0.2% PMI factor applies to the $360,000 loan amount:

$360,000 X 0.2% = $720 annually

$720/12 = $60 as part of your total monthly housing payment.  This is a small price to pay to buy your home now instead of saving another $40,000 to avoid PMI with 20% down.

Assuming an interest rate of 5.5% results in principal and interest (P&I) of $2044 per month.  The total payment with $60 PMI added is $2104 per month.

How Do You Remove PMI?

PMI payments are automatically removed by your servicing lender once you pay the loan balance down to 78%.   Once you pay the loan balance down to 80% of the original value, you can request to remove PMI.   Adding additional principal payments over time will reduce the loan balance faster, remove PMI sooner, and increase the equity in your home.

Run the numbers for your situation with a Mortgage Calculator.  Input the PMI factor from above to view your estimated monthly payment.  You can also run an amortization table to see how long it will take to pay the loan down to 80% of the value.

What if your credit score isn’t all that good?

The same down payment would result in a higher PMI factor if your FICO score was 660, for example.  PMI pricing is risk-based, meaning that the lower your credit score, the higher risk of default, so PMI is more expensive:

The same $400,000 home with 10% down ($40,000) means the 0.60% PMI factor applies and works out like this:

$360,000 X 0.60% = $2160

$2160/12 = $180 added to your total monthly housing payment.  This is $120 more per month (triple the cost) for the PMI at the same down payment, simply due to the lower FICO score.

Knowing your FICO score when determining your financial ability to buy a home is incredibly important.   That way you can take the steps necessary to build solid credit, saving you thousands of dollars in extra costs and fees to obtain your new home.  

Your FICO score is crucial in securing the best possible rates and pricing for your new home purchase.  Learn building a solid credit score here.

Are There Other Home Buyer Programs That Can Help?

Yes!  Programs are available through Fannie Mae and Freddie Mac that reduce rate pricing and PMI costs as long as you meet certain conditions, such as:

• Meet Area Median income limits for your State/City.
• Attend Home Ownership Counseling.

If you meet the criteria found under the Home Ready program for Fannie Mae or the Home Possible program for Freddie Mac, then they are worth pursuing, even if you have excellent credit.

Are There Alternatives to Monthly PMI?  

Yes, but these options are not free.  However, they may work well for you depending on your home purchase goals.  

Home Equity Line of Credit (HELOC) is a popular option to consider as an alternative to PMI but  depends on the HELOC options available in your region.  The HELOC 2nd mortgage is used to cover a portion of down payment to allow for less than 20% down without PMI.

For example, an 80/10/10 is an 80% 1st mortgage, 10% 2nd (HELOC), and 10% down payment.  Choose a 75% 1st mortgage instead of the 80% option if buying a condominium as interest rates are much better structured this way.

How Does a HELOC work?

First, determine available HELOC options through your mortgage lender during the purchase process so the paperwork is completed simultaneously.  Since HELOCs are a bank/credit union product (like credit cards and car loans), there are many options to choose from when establishing your HELOC.

The most common is an interest only line of credit with a variable rate based on the Prime Rate plus a “margin” as determined by the bank or credit union.  The Prime Rate is reported in the Wall Street Journal and is the benchmark used when setting HELOC.  The margin is the amount they charge above the WSJ Prime Rate for your total rate.

For example, as of today (Sept 2022) the Prime Rate is 6.25%. A HELOC at Prime + 1% is 7.25% until the Prime Rate changes.   

When the Federal Reserve (FED) cuts rates, the Prime Rate is directly impacted by the change (the FED directly controls the Fed Funds rate but the Prime Rate tracks this rate).

Using the $400,000 home purchase example above with 10% down ($40,000) but instead, setup a HELOC for $40,000 and an 80% 1st mortgage at $320,000:

The payment on the 1st mortgage at 5.5% interest rate = $1817 principal and interest. 

The HELOC payment is typically interest only at a minimum, so the calculation is simply:

(Loan Amount X Rate)/12 = Minimum Monthly HELOC Payment

($40,000 x 7.25%)/12 = $241 per month interest only

The total payment would be $2068 for 1st and 2nd mortgages.  This is currently $36 less per month than the total payment is for a $360,000 loan at 5.5%, including the PMI.  

The HELOC option is usually variable rate and the minimum payment is interest only.  You have to pay additional each month to reduce the principal and the interest rate can go to a maximum 18%.  The likelihood this is very small, but certainly possible, especially since we are in a rising rate environment.

Some banks and credit unions run special “teaser” rates to provide a low fixed rate for 1-5 years.  No two banks or credit unions offer the same HELOC options, so shop around and select the right HELOC for your situation. 

There are long term fixed rate options for 2nd mortgages as well but the terms are typically shorter, 15-25 years, and the fixed rates typically higher, in the 8%+ range.  The resulting payments are high enough with fixed rate options that paying PMI tends to be a better selection.

FHA Loan Options

FHA loans have a minimum down payment requirement of 3.5% include monthly PMI and require an upfront MIP (Mortgage Insurance Premium) of 1.75% of the loan amount.  This fee can be financed into the loan at the time of closing but is an extra cost to consider.

This table shows the cost of borrower paid monthly PMI for FHA loans.  (numbers below reflect percentage of your loan amount annually for 30 Year Fixed loans at $625,500 or LOWER):

If you have a good credit score, you will likely be able to secure a lower monthly PMI with conventional lending.  But, if you have a marginal to low FICO score, especially below 660, the FHA loan is a great option to consider.

Conventional lending is more penalizing for lower FICO scores whereas the PMI for FHA loans is not FICO dependent.  For FHA, you just need sufficient credit to be approved for the loan and in general, need at least a 580 FICO score.

A major consideration with FHA financing is the PMI does not go away if you put less than 10% down.  The PMI will stay with the loan for the entire term.  If you put 10% down or more, then you can eliminate the PMI after 11 years.

You can always refinance to a conventional loan a few years after taking ownership but there is no guarantee the interest rates will be low enough for this to make financial sense.

USDA (Rural Development) Loan Options

USDA loans do not have a minimum down payment requirement but do have maximum income restrictions and are only available in certain rural areas of the United States.  Learn more about USDA loan requirements here. 

The USDA loan program requires an upfront MIP but is only 1% of the loan amount.  This fee can be financed into the loan but is an extra cost to consider.

The PMI for USDA loans is 0.35%.  This is significantly less than FHA and better than low down payment conventional options.  The downside with USDA is the PMI continues for the life of the loan although it decreases over time as you pay down the loan balance.

If you are looking to buy in a USDA eligible area and meet the income limitations, this is a great alternative to consider for your home financing.

Summary

There are many options available to you to help you purchase a home with less than 20% down.  Some options are better if this will be a short term home purchase versus a long term purchase and some are better for marginal credit versus excellent credit.

Your financial situation and home ownership goals are unique and of primary importance when shopping for your home loan. 

Spend time to locate the services of a professional mortgage loan officer, one who understands how to tailor your financing to meet your needs and serves your home ownership goals.