When the time came to finance our new house earlier this year, my husband and I had already decided: We were going to do everything we could to put a 20% down payment toward our mortgage—we were definitely not going to get saddled with PMI.
Many home buyers are conditioned to hear “PMI,” or private mortgage insurance, and panic. It is essentially a premium you pay if you don’t have 20% to put down on a home.
And if you asked me six months ago, PMI was synonymous with flushing money down the toilet. But after my husband and I took a close look at our finances, we both had a change of heart.
These days, I’d even call myself a PMI advocate. Why? Let me break it down.
What is PMI and why does it get a bad rap?
PMI protects your lender in case you default on your loan. If you make a 20% down payment, you don’t have to pay PMI; but if you put down less than 20%, your lender requires you to pay a monthly premium. The way lenders see it, they’re taking on a bigger risk with a borrower who puts less than 20% down. The insurance covers the lender in case you can’t make the payments on your house.
It sounds straightforward enough, but an internet search for PMI turns up a slew of articles about how to avoid it. So why the hate for PMI?
“PMI is an insurance premium that the borrower pays that has no benefit to them,” says Jennie Jacobson, mortgage loan consultant at Orange County’s Credit Union. “This premium results in a higher [mortgage] payment, which no borrower wants to hear.”
That was the case for me. Better to make a big down payment upfront than to throw away money on PMI, right?
Not always, experts say. When used properly, PMI is a tool that can actually help you build wealth.
Here are a few examples of when PMI can be more of a blessing than a curse.
1. PMI puts homeownership within reach
A 20% down payment is a lot of money. Even on a $100,000 property, that’s $20,000 in liquid cash—plus the money you’ll need for closing costs and other expenses, like replacing the furnace and furnishing the home.
For some hopeful homeowners, access to that much cash simply isn’t feasible. But rather than walking away from your dream home because you’re not rolling in dough, you can use PMI to put homeownership within reach. It helps you qualify for a mortgage you wouldn’t otherwise be approved for.
Plus, PMI doesn’t last forever. You can have PMI removed once you reach 20% equity in your house, or if you have your home reappraised after making upgrades.
PMI also helps approved buyers obtain conventional mortgages with a lower down payment, which can be preferable to FHA loans. FHA loans allow buyers to put as little as 3% down, but they also generally come with higher fees than conventional loans and require buyers to jump through more hoops.
2. PMI is an attractive option while interest rates are low
When interest rates are high, it makes sense to reduce your loan burden as much as possible. But when rates are low, taking out a bigger mortgage and making a smaller down payment is a smart way to keep more of your money in the bank.
“If interest was 15%, I’d be saying ‘PMI is the devil, put 20% down,’” says Alex Filin, vice president of mortgage lending at Guaranteed Rate in Chicago. “But rates are so low you have that option.”
Today, the average interest rate on a 30-year fixed mortgage hovers just under 5%. It’s been creeping upward over the past several years, but it’s still a far cry from the 1980s, when mortgage rates surpassed 18%—a time when home buyers were wise to pay down their homes on the front end as much as they could.
3. PMI lets you leverage your money
For my husband and me, the biggest benefit of PMI was that it freed up the money we had set aside for a down payment, and allowed us to put that cash toward other expenses—like renovating our turn-of-the-century home, and paying off my husband’s grad school loans (which carried a higher interest rate than our mortgage).
Filin looks at it this way: “PMI is the fee you pay to keep your money in your bank.”
For us, keeping our money in the bank (or putting it toward other expenses) is well worth the $75 per month we now pay in PMI, which amounts to about 0.5% of our home loan. Even with our PMI payment, we stand to save at least $500 in student loan interest.
For some home buyers, making a 20% down payment could also require wiping out their entire retirement or emergency savings—something you never, ever want to do in order to buy a home.
“Your home should be your nest, not your nest egg,” says Wendy Landis, senior loan production manager at GMH Mortgage Services in Hunt Valley, MD. “Once you put money down on your home, the only way you can get it back out is by borrowing against your equity or selling.”
The bottom line: When interest rates are low, there are better ways to invest your down payment money. And even if you don’t need the cash to pay off bills, you could invest the cash at a higher rate of return than what you pay in mortgage interest. In doing so, you’ll not only break even on PMI fees, but you’ll also keep your money within reach for a rainy day.
But PMI isn’t a good option for everyone
Your credit score is a big factor in determining your PMI rate, Filin says. If your credit score doesn’t make the grade, your PMI payments could skyrocket. In that case, you might want to make a larger down payment, or take some time to improve your credit score and reduce the cost of PMI.
For me, PMI stopped being a dirty word once I started to look at it as a tool for leveraging my money. But there’s no one-size-fits-all approach to financing a house. Your mortgage broker or loan officer can help you weigh the pros and cons of PMI and find a solution that fits your needs.