My wife and I are looking into buying our first home within the next year and have been looking into the 5% downpayment vs 20% downpayment debate. I have learned that if I plan to put down less than a 20% downpayment then my wife and I will have to pay Private Mortgage Insurance (PMI) on top of our monthly mortgage. The article below summarizes my research into the three main reasons I think PMI sucks and should be avoided: no built equity, PMI can last for 10 years, and it can be hard to get out of.
Private Mortgage Insurance (PMI) is paid on a monthly basis if your home mortgage is greater than 80% of the home’s value. So if you make a 20% down payment on a house, you instantly have 20% equity in the house and avoid paying PMI. In essence it is insurance for the bank that if you default on the loan (which means you can’t pay your mortgage), the bank is guaranteed to avoid a loss.
No Built Equity
The biggest issue with PMI is that you get no return from it. It is a sunk cost that you must pay each month to protect the bank in case you default. PMI can cost per month anywhere from 0.5% to 2% of your home’s value each year. So, if you put down 5% on your house and have a $100,000 mortgage, your payment could include up to $83 a month on top of your mortgage! ($100,000 x 1% of home value / 12 months).
It gets more extreme the greater your mortgage. If you only pay 5% down and take out a home loan of $150,000, $200,000, $300,000 ect… you are paying up to an additional $125, $166, $250 a month! For that amount of money you could lease a car (which I do not recommend)! Yet you see where I am getting? Unlike the actual mortgage, there is no equity built; you get no return from this payment.
PMI Can Last For 10 years
The thought goes that since you start at 5% equity, you only need to accumulate 15% more equity in the house before it goes away. This is almost correct. The thought continues that 15% of 30 years is 4.5 years, so in 4.5 years I will be done with PMI! Nope. Not so fast.
Due to the payment structure of a 30 year mortgage and how the interest is weighted throughout the loan, depending on your interest rate it can take between 7 and 10 years to get to 20% equity in your house if you only put 5% down. That same $125, $166, $250 a month PMI cost can end up totaling $14,250, $18,924, $28,500 (PMI per month x 12 months x 9.5 years) on your journey to 20% equity. So not only does this $166 extra payment drag down your monthly budget, you may have it for almost a decade.
PMI Can Be Hard To Get Out Of
My final interesting point that I came across while preparing this article is that PMI does not just “go away” after you reach the magical 20% home equity mark. Surprisingly, you have to request removal of PMI in writing. If you do not request it, the PMI will continue to be charged until you reach 22%, at which point the bank is required to remove PMI.
Due to this, it can take months for it to be removed from your monthly house payment as forms have to be filled out, a house value assessor may need to come over to determine how much your home is actually worth, and on and on. This process can take months. Months of still paying PMI even though you have over 20% equity in your home.
If At All Possible, Avoid PMI
In summary, PMI should be avoided at all costs. The only benefit to the consumer is that it allows a relatively small upfront cost in order to get into a house. I understand the desire to get into a house quickly, but a review of the negatives should be fully understood and accepted. Ultimately, paying $166 a month for 7-10 years is a lot of money to make sure the your mortgage lender sleeps well at night.