You can get a mortgage without putting 20% down, but if you do, you’ll pay PMI (Private Mortgage Insurance). While PMI has a bad reputation, it’s a helpful tool to get a mortgage before you have a large down payment.
So, what is PMI? Here’s everything you need to know about it and how it works.
What is PMI?
PMI is insurance that protects the lender should you default on your loan. If you qualify for conventional financing and have less than 20% to put down, you’ll pay PMI. This isn’t a bad thing, though.
PMI is insurance premiums you pay that cover the lender. Since you only have a little bit invested in the home, the lender requires insurance coverage that would pay them if you defaulted on the loan (stopped paying it).
Think of it as a way to help you own a home much faster without requiring government-backed loans that require mortgage insurance for the entire term.
How does it Work?
PMI has a monthly premium you pay with your mortgage payment. The amount you pay depends on your loan-to-value ratio and credit score. The more money you put down on the home and the higher your credit score is, the less PMI you pay.
It’s all based on your risk factors. You’re a riskier borrower the less money you invest. Lenders call it ‘skin in the game.’ They know you’re more likely to do what’s necessary to make your payments when you have your own money at stake to lose.
Your credit score also matters. The higher your credit score is, the lower your risk of default becomes because a high credit score shows that you are a responsible consumer.
Can you Cancel PMI?
Here’s the good news. PMI doesn’t last forever. You can ask the lender to cancel it once you owe less than 80% of the home’s value. Lenders will determine if you’ve made your payments on time and are a ‘good borrower.’ If so, they’ll cancel your PMI.
If not, by law, they must cancel it once you owe 78% or less of the home’s value.
Is there a Way Around PMI?
If you don’t like the idea of paying PMI, here are the simple ways around it.
Make a down payment larger than 20%
Take out a piggyback loan (2nd loan to cover 10% of the down payment) and put down 10% of your own funds
Take out a portfolio loan (non-conventional or non-government-backed loan)
When you wonder ‘what is PMI’ don’t assume it’s bad. It increases your mortgage payment temporarily, but if you make your payments on time and/or make extra payments, you can eliminate PMI quickly.
It’s the only way to get conventional financing with less than 20% down. In short, it allows you to own a home faster without having a lot of money to invest in it right away. As your income increases or you can make higher payments to your mortgage, you can eliminate PMI faster.