Private Mortgage Insurance and Down Payments

Private Mortgage Insurance is commonly referred to as PMI. It’s not insurance for the borrower, but rather for the lender. The coverage is paid to the lender if a borrower defaults on a loan. PMI sometimes leads to confusion in the industry when it comes to down payments so allow me to break it down a bit.

You may hear that 20% is what’s required for a down payment when financing the purchase of a home, but that’s not accurate. In many cases, lenders require only 3% – 5%. This is much more realistic for many buyers and particularly young, first-time buyers. Having said that, at 3% – 5%, the lender is taking some risk given that it’s possible the new homeowner could default on the loan, but this is where PMI kicks in. The PMI cost is roughly 1% per year. Variables which may affect that percentage can include the borrower’s credit score, the exact percentage of the down payment, and whether or not the loan is an Adjustable Rate Mortgage (ARM) or a Fixed Rate Mortgage.

Loans backed by the federal government such as those by FHA (Federal Housing Administration), VA (Veterans Administration) or USDA (US Department of Agriculture) operate a little differently. Those agencies back the loans for the lender. The lender, still lends the money, but their risk is minimized by those aforementioned agencies. Despite the VA not requiring a down payment, I’d like to point out one caveat pertaining to their loan. The VA does require a funding fee, which is often around 1% – 2% paid at the time of closing. However, disabled Veterans who meet the minimum disability rating, are exempt.

Here’s where the confusion over down payment requirements come. If the borrower chooses to pay 20% or more, PMI is not required. This is because the borrower has more skin in the game and there’s less risk for the lender. To make this a little more complex, there are some lenders who offer “lender paid PMI”, but it’s in exchange for a higher rate. Bottom line up front – down payments are usually 3% – 5%, but 20% is the threshold to eliminate PMI. Also, once the borrower pays down approximately 80% of the loan, they can request to cancel PMI, but their payment history is considered. VA and USDA do not require PMI or down payments, while FHA has an alternative insurance.

Now, let me go back for some clarity pertaining to those three federally backed loan programs.
1. FHA loans usually require 3.5% down and it’s an option for those with lower credit scores.
2. USDA loans don’t require a down payment and are for lower to moderate income buyers, primarily in rural areas.
3. VA loans are for Veterans or those currently serving in the military. Sometimes you’ll hear they’re for active duty service members only, but those in reserve status can often qualify.

There are more details and scenarios than I can cover in this one column, so please realize that you need an experienced REALTOR® who will also recommend a good lender to you.

Brian McCommon, 2024 MBOR President