If you’ve been looking to buy a home, you’re probably aware that it’s hardly an inexpensive prospect these days. Not only are mortgages more expensive to sign, but a persistent lack of real estate inventory has driven U.S. home prices up in a very big way.
You’ll generally hear that it’s a good idea to try to make a 20% down payment on a home when you’re signing a conventional mortgage. The reason? If you don’t put down 20% at closing, you’ll be hit with private mortgage insurance, or PMI. Private mortgage insurance is an extra fee you’re charged on top of your monthly mortgage payments (there can be other ways to pay PMI, but paying it monthly is most common).
PMI might sound like an extra means of protection for you, but don’t be fooled by the word “insurance.” The purpose of PMI is to protect your mortgage lender in the event that you fail to make your home loan payments when you’re supposed to. So it’s a good idea to try to put down 20% on a home purchase to avoid it.
Unfortunately, though, recent Realtor.com data shows that while home buyers are making larger down payments these days, many aren’t hitting the 20% mark. And that means a lot of people are sentencing themselves to PMI on top of the generally high expense of owning a home.
What buyers are putting down today
Realtor.com reports that down payments on homes actually reached a new peak during the third quarter of 2023, with a median down payment of $30,400. A year prior, the median down payment was $27,300. And the year before that, it was $22,300.
But a down payment of $30,400 still only amounts to an average of 14.7% down at closing. That’s below the threshold required to avoid PMI.
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Why it pays to avoid PMI
The good news about PMI is that you can eventually get it canceled once you have enough equity in your home. The bad news, though, is that if you make a down payment of less than 20%, you could get stuck paying PMI for a pretty long time. And that added cost might make an already large expense — homeownership — even harder to manage.
PMI usually amounts to 0.5% to 1% of your mortgage amount. So if you’re taking out a $240,000 mortgage, PMI might amount to $1,200 to $2,400 a year. That’s an extra $100 to $200 a month. Imagine you’re spending that extra money on top of your mortgage payments, property taxes, maintenance, and repair costs. That’s a lot to swing.
Plus, putting down less than 20% at closing leaves you with less equity in your home to start off with. If the housing market tanks shortly after you buy your home, you could end up in a situation where you’re underwater on your mortgage — meaning, your home’s market value is less than what you owe your lender. This could be a problem if, say, you need to sell your home right away to take a new job or to deal with the loss of a job.
That’s why it may be a good idea to consider buying a less expensive home or putting off homeownership if you don’t have enough money to make a 20% down payment. This isn’t to say that paying PMI for a period of time is the worst thing in the world. But it’s an added expense you may be able to avoid if you reset some expectations on the home-buying front or otherwise sit tight for a few months.
If you don’t want to do that, know that you won’t be alone in paying PMI. But make sure to budget for that expense accordingly. Find out what your PMI will amount to and make certain you can afford that expense on top of your other homeownership costs.
