Conventional Mortgages Under 20% Down Without PMI
Many people have heard about the benchmark of 20% down payment when buying a home. That's the traditional benchmark for avoiding PMI.
But did you know there are situations you can avoid PMI with less than 20% down payment? There are also ways to reduce the cost of it. We'll explore all of that. First, let's try to clear up some misconceptions...
What is PMI?
Private Mortgage Insurance (PMI) is an extra expense that indirectly allows you to get a Conventional loan with a smaller downpayment.
Rather than thinking of it was a "waste of money", think of it for what it is -- an expense that allows you to get a loan you couldn't otherwise get.
How does PMI work? It supplements the limited backing offered through conventional agencies to mortgage lenders. It protects the lender, not you.
Challenging Two Popular PMI Myths
People often think of PMI almost as a "money grab" against consumers. But that's not true at all. Lenders typically rely on a handful of third party PMI companies for PMI policies. Lenders don't profit from these policies. One of the most successful PMI companies, MGIC, nets roughly 10% of its overall revenue as net profit. That means 90% of its revenue is paid toward expenses, including payouts on loan losses. As a business, it's similar to other types of insurance.
Secondly, people often think of PMI as extremely expensive. It seems like people hear about the most expensive examples. In reality, the cost of PMI corresponds to a scale of risk. Higher down payments (like 15% down) involve less risk than low down payments (like 3% down) and cost significant less. People with exceptional credit scores pay significantly less than people with below-average credit scores. You might have heard someone paying $250/month for PMI, but another PMI policy may cost just $15/month.
Challenging the 20% Benchmark Focus
It's true than making a down payment of 20% is one way to avoid Private Mortgage Insurance (PMI). Some people have such strong feelings about this that they want to reach the 20% benchmark at all costs. But in reality, it's not so black and white.
I would like to give you five reasons not to obsess over the 20% benchmark --
In some cases, there's no PMI with 15% down. We have a special lender-paid program where we can purchase the PMI policy as the lender on behalf of the borrower. There are some cases where the net cost to the customer is zero. That normally happens for borrowers with exceptional credit scores (normally over 740 or 760) with shorter loan terms (20 year or 15 year). In other words, the borrower receives the same rate they would receive with 20% down, with no extra closing costs, and with no extra cost in any way for PMI.
This program can be a huge benefit and help you keep more money in-hand even if you have 20% down available.
In some cases, the cost of PMI is extremely small. In some cases, the special lender-paid program mentioned above result in a very minor indirect cost to the customer. We can handle it in different ways. Sometimes it's a small bump to the rate or an extra cost at closing. The costs depend on a variety of factors including credit score, loan amount, and percentage of downpayment. The costs can range from significant to almost nothing. Whatever it is, there's often a way to make it smaller (keep reading)...
Regular PMI is temporary. If you do receive a regular PMI policy where you pay the PMI each month, there are two ways to get rid of it. First, you can reach the 20% benchmark based upon your value increasing and/or paying down your loan. In this case, you will need to pay for a new appraisal. Second, you can wait until the loan is scheduled to reach the 22% equity benchmark. That benchmark doesn't require a new appraisal. In some situations (such as 15% down with a 15-year fixed, that benchmark comes very quickly).
You may be able to exchange PMI for a small rate bump. We also have a self-insured PMI program (which means we're buying the policy behind the scenes), where we can often give you a small rate bump instead of PMI. The bump depends on a variety of factors including credit score, downpayment, and loan amount. It can range from significant to as low as .125% (for example, 4.625% instead of 4.5% as a hypothetical illustration). Is it worth it? Possibly! It depends on the situation.
There's an opportunity cost to waiting. The longer you continue to wait, the longer you're paying rent, not building equity, and the longer home prices are increasing. In many cases, the increase in home prices over time can far outweigh any cost you save on PMI.
On the other hand, sometimes it is worth waiting. Sometimes PMI is expensive -- especially for people with poor credit and low down payments. These people compare conventional options to other options such as FHA anyway.
The point is, don't put off your home purchase without exploring your options. PMI may be more affordable than you thought. In some cases (as mentioned in the first point), it may cost nothing.
If you'd like us to help you explore, simply go to Get Started Online.
Three PMI Options (3 Ways to Pay PMI)
Borrower paid monthly. This is the regular, well-known option. The borrower pays it as part of the monthly payment. It could be small or large, depending on the factors.
Upfront one-time premium. This is a lesser-known option. Instead of paying it monthly, the borrower pays it one-time at closing. This often costs less over the long-term.
Lender-paid upfront, one-time premium. This is also a little-known option. In this case, the lender pays it. Normally the lender would make a bump to the rate -- or a combination of a rate and cost bump -- to offset their cost.
However, there's some "weird stuff" in the way mortgages are priced. Loans with PMI are sometimes priced slightly better than loans with 20% down (probably due to the extra protection PMI offers the lender), and this slight pricing differential itself can sometimes pay for a low cost PMI policy. That typically happens for borrowers with exception credit, 15% down, and 20 year term.
I realize all of this is abstract to you at this point...
Don't worry about figuring this out by yourself. Let us help you. We'll help you explore your options and make it easy to compare-and-contrast when you get in touch. If you're searching for a home within the next three months, your first step is to complete the information at Get Started Online.
Six Ways to Avoid PMI
Make a down payment of 20%. This one is well-known. So let's go to the next...
In some cases, make a down payment of 15%. As explained above, sometimes it's possible to avoid any PMI cost with 15% down. This is our special program for borrowers with exceptional credit and shorter loan terms (20 or 15 year).
Exchange PMI for a rate bump. In some cases, the rate bump is extremely minimal and will impact your payment considerably less than the monthly payment of PMI. We can help evaluate if this makes sense.
Pay PMI as a lump-sum payment. This isn't a way of "avoid" PMI, but it's a way to avoid the monthly cost of PMI. In some cases, that upfront lump sum is much less than what you would pay over time with monthly PMI.
Get a second mortgage. Okay, we short-handed the terminology earlier. It's not technically the "down payment" that determines whether you get PMI (e.g., 20% down payment), but the percentage of the first mortgage itself to the purchase price/appraised value (e.g., 80% loan-to-value ratio).
So if you had 10% down, one way to structure it would involve placing your 10% down and splitting the 90% financing into a first and second mortgage. The problem is, sometimes the cost of a second mortgage outweighs the cost of PMI, especially when the PMI is on the minimal side. This option isn't very common, but we can explore it.
That's only five ways. What about the sixth? The sixth way is another way to avoid the maximum degree of PMI. It's a way to significantly lower the overall cost through two big factors -- (1) reducing the monthly payment and (2) reducing the time you keep it.
Let's explore it below...
Illustration on How to Significantly Reduce PMI
Let me give an example that illustrates this point...
Recently I met with a customer with a lower credit score (665) and a small down payment (5%) to help her plan her purchase.
To put it in perspective, she was planning to buy a place around $160,000. The combination of lower credit score and low downpayment made her PMI pretty expensive on a 30-year term.
So we checked out a 20-year term. The principle and interest (P&I) mortgage payment on the 20-year term was about $200 per month more than the 30-year term. Not too bad to reduce 10 years from the term, right? But guess what...
When we checked out the total payments (PITI -- principle, interest, taxes, insurance), the 20-year payment was only about $103 per month more than the 30-year. Why is that?
It's because the Private Mortgage Insurance was $97 per month less expensive on the 20-year option.
That difference was large enough to put the 20-year payment almost in the same ballpark as the 30-year payment!
So that tip alone could be huge!
It could save you a large amount of money (in this case almost $100/month in PMI), plus help you pay off your loan, and build equity much faster.
But the difference is even more than you may think. Although there are various ways to eliminate PMI after you have it, let's assume this customer kept the PMI the maximum time (until she was scheduled to reach 78% of the purchase price)...
Here's when the PMI would come off:
30 year: Month 117 (about 10 years)
20 year: Month 63 (about 5 years)
(Note these timeframes are longer because she was doing 5% down. They're much shorter with 10-15% down)
So let's say she kept the home for 10 years total. On PMI, she would save:
$97 per month for the first 62 months. $97 x 62 = $6,014
$201 per month for the next 55 months (months 63-117). $201 x 55 = $11,000
Total savings: $6,014 plus $11,000 = $17,014
Also, she would have over $29,000 more equity at the 10-year mark on the 20-year term.
Do you see how finding the right structure for your loan is far more powerful than over-focusing on minimal rate differences between lenders? This is why it's so important to work with someone who can help you explore.
I'm happy to help you explore. If you're searching for a home within the next three months, start out by completing the information at Get Started Online.
This relates to just one of five layers of options I always emphasize. The five layers of options far more deeply impact your long-term outcomes that the limited differences in margins on rates/costs. Here's the bigger picture --
Five Key Layers -- The Bigger Picture
Sometimes, people get overly focused on just one aspect like "what's the rate?" or "what's the cost of PMI?" By focusing on one aspect, they loose the bigger picture, and they overlook strategies to align many inter-connected parts for the maximum benefit. The illustration above shows a good example.
Instead of focusing on just one aspect, we should explore your options together. There are five key layers of options that together impact you far more than any one aspect.
These are five key layers of options --
1. What program (e.g., Conventional, FHA, VA, USDA, ect)
2. What downpayment (5%, 10%, 15%, 20%, 25% are most common for Conventional)
3. What term (30, 20, 15, 10 year fixed or 5/1, 7/1, 10/1 ARM)
4. What option on the rate-cost continuum (usually 3-4 viable options)
5. When and how long to lock (15 day, 30 day, 45 day, 60 day, ect.)
The difference we identified above came from layer 3. That layer in the story above probably impacted the overall picture -- especially the cost of PMI -- more than anyone would have thought.
The best way to explore in a more personalized way is to get in touch with us through our Get Started Online portal. This will give us the information we need in the first place to do any meaningful comparisons. Without this step, you could be gathering information completely disconnected from your personal situation.
Let's Work Together
As you can see, we approach this process very strategically. We think outside the box to find the right combination of options for you. We're very straightforward about the pros and cons of each option.
When we learn about your personal situation, we can find, compare, and contrast options that seem best suited for you. We'll make them easy to compare side-by-side.
Equally important, we'll give you a distinct advantage for getting your offer accepted if you're searching for a home. When seller's agent sees that we're providing your financing, it inspires confidence because of our strong reputation in the local real estate community. On top of that, our VIP FasTrak program can give you an actual head start, allow you to close more quickly, and set you apart from other buyers who are at much earlier stages of the mortgage process.
Frequently Asked Questions
Q. How much is PMI on a conventional loan?
A. As we discussed above, it depends on many factors including your loan term (e.g., 30, 20, 15), down payment (e.g. 15%, 10%, 5%), and credit score.
Using the creative methods discussed above, we can explore options to minimize your PMI. Please get in touch through our Get Started Online page so we can provide accurate information for your situation.
Q. When can you drop PMI on a conventional loan? How can you get rid of PMI?
A. There are two ways to drop it once you have it:
(1) Borrower requested termination. Validate that you have at least 20% equity with a new appraisal. You'll have to pay for this and order this through the lender who services your loan.
(2) Automatic termination. It automatically drops off at the point you're originally scheduled reach 22% equity based on the original value (lower of purchase price or original appraised value) of your home.
Q. How long do you have to pay PMI on a conventional loan?
A. Using the first method (above), it depends on how quickly you pay down your mortgage and how fast your value increases ("appreciation").
For most buyers making minimum payments on a 30-year fixed with 5% down payment, it will typically take about 5 years, assuming an appreciation rate of about 3%. However, appreciation rates vary by market.
For buyers making a larger down payment (more than 5%) or paying at a faster pace, that time would come sooner.
Significant improvements to your home may also speed up the timeframe that you reach 20% equity.
The automatic termination point (above), for a buyer with a 30-year fixed and 5% down payment, typically takes about 9 to 10 years. This point would come more quickly with a larger down payment or shorter loan term.
Q. How much will my PMI be?
A. As you can see in this article, there is a wide variance in potential PMI costs. Together, we can approach PMI very strategically. Let us help you weigh your options, consider ways to reduce or eliminate PMI, look at the full picture, and find the option that fits you best. We can identify particulars once you get in touch with us through our Get Started Online page.
Thanks for the Info. Please Help Me Explore My Options!
Yes, we'd be happy!
Not all lenders offer these options, but we work with these options on a regular basis. People normally don't think of various options for PMI itself, but this is one of the many details we'll be happy to help you explore and compare.
The cost of PMI is part of the Total Cost Analysis we can share with you. The Total Cost Analysis provides a visual summary with easy-to-read charts to help compare your options.
Here's how you can get more information:
If you hope to purchase a home in the next three months, go to the Get Started Online section. Fill out the information, and this will help us get to know you and figure out what options we can help you explore. We can provide a Total Cost Analysis at that time.
If you're beyond three months away, we'd be happy to do an informal, free consultation over the phone. This will help you plan and prepare. Use the contact form below to get in touch.