Ask a loan officer about down payments and mortgage insurance, and she'll probably give you the standard response: Put down anything less than 20 percent of the purchase price and for a while you're going to make monthly private mortgage insurance payments. Put down the minimum, which is usually 3 percent of that price, and you may, if you borrow through the Federal Housing Administration, have to do so over the full term of the loan. That's the standard rule for down payments and insurance, but home buyers are increasingly looking for ways around it. And some are finding them.
Why It's Worth Avoiding PMI
Borrowers don't directly benefit from private mortgage insurance (PMI). It exists to protect the lender in the event the loan goes sour, so the only advantage the homeowner gets is an ability to borrow a bigger proportion of the purchase price.
But that ability comes with a hefty price tag. PMI payments can easily add $100 a month to a household's outgoings, and often $200+ for larger loans. Just how much you personally would have to pay will depend on a number of factors, including your credit report and score, the amount of other debt you have and the size of the down payment you're going to make.
3 Percent Down and No PMI
Right now, lenders that allow a minimum down payment of 3 percent and no PMI are rare, although they could become more common. That might depend on the success or otherwise of a new program from Bank of America, Freddie Mac and a non-profit loan fund formed by the Self-Help Credit Union. It has engineered a redistribution of risk that allows it to offer PMI-free loans even to those with that low down payment. However, there are some strict eligibility criteria, including a reasonable credit score, a household income at or below the area's median and a loan amount below $417,000 in most parts of the U.S. You can also expect to pay a slightly higher interest rate than you would if you were paying the insurance.
Of course, there is a group that's entitled to PMI-free mortgages even if they make a zero down payment. Those eligible for loans backed by the U.S. Department of Veterans Affairs (VA loans) need never make mortgage insurance payments, because their service earned them an exemption.
Other programs that can reduce or eliminate the cost of PMI include Fannie Mae's HomeReady mortgages, and USDA loans from the U.S. Department of Agriculture, though the latter are available only for properties located in eligible low-density areas.
No PMI Easier With Private Lenders, Credit Unions
The rules that govern loans backed by Fannie Mae, Freddie Mac and the Federal Housing Administration (FHA) are rigid: Make a 20 percent down payment or pay either PMI or a higher rate that allows the lender to pay the PMI. But private lenders and credit unions are free to set their own lending standards, and some are willing to be more flexible.
Few are interested in helping buyers with just 3 percent to put down, but many seem increasingly willing to be flexible when it comes to those with more. One way of avoiding PMI is the "piggyback loan," which involves partly financing the 20 percent down payment on the main mortgage through a second mortgage, sometimes a home equity line of credit (HELOC). This can be an effective way to dodge PMI payments and a very affordable form of borrowing.
However, it's important homeowners recognize the risks that these HELOCs present. First, they generally come with variable rates. And secondly, it's vital that borrowers are disciplined in paying down balances on schedule or they may face a crisis when the line of credit switches from its initial "draw" period to its "repayment" phase. Learn more at How to Beat the HELOC Monster.
Boost Your Down Payment
One way to avoid or reduce PMI payments is to increase your down payment. Ideally, that involves saving more, but with home prices in some areas increasing quickly, that can soon turn into a losing battle.
So you may wish to consider borrowing your down payment – or at least some of it. This can get you onto the housing ladder sooner, give you access to today's ultra-low mortgage rates before they rise and allow you to keep back a worthwhile emergency fund. However, most loans come with higher interest rates than mortgages, so you need to be sure you can afford the payments on all the borrowing you're taking on. Model your options using mortgage calculators.