Smaller down payments can help first-time homebuyers get in the door, but it comes at an extra cost

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A 2018 report from Realtor.com revealed that millennial homebuyers are taking on bigger mortgages than ever before — a result of more millennials buying higher-priced homes and making lower down payments.
Private mortgage insurance (PMI) is required for homebuyers who pay less than 20% of the purchase price up front and take on a non-governmental housing loan. It protects the lender if the homeowner were to stop making their mortgage payments.
Mortgage insurance can cost anywhere from 0.3% to 1.2% of the loan’s principal balance, and is commonly paid to the lender as part of the homeowner’s monthly mortgage payment.
Once a homeowner reaches 20% equity, they can apply to have mortgage insurance removed from their monthly payments.
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Millennials were on a homebuying tear at the end of 2018, when the generation aged 19 to 37 was responsible for the largest share of new mortgages by dollar volume in the US, according to a previous report by Realtor.com.

The uptick in mortgages is a result of millennials as a group buying more homes than ever, and, individually, making lower down payments despite rising home prices, which require larger mortgages. As of December 2018, homebuying millennials made an average down payment of just 8.8% of the purchase price, according to a Realtor.com analysis of Optimal Blue mortgage loan data.

But while a smaller down payment can help first-time buyers get in the door, it comes at an extra cost. In addition to higher monthly payments from a bigger mortgage, buyers who put down less than 20% of the purchase price and take on a conventional loan — i.e. not a governmental housing loan — must pay for private mortgage insurance (PMI).

PMI basically protects the lender if the homeowner were to stop making their mortgage payments. The exact cost of PMI is detailed in the loan estimate, but it can range from 0.3% to 1.2% of the loan’s principal balance, according to insurance-comparison site Policygenius. Put another way, homeowners can expect to pay between $30 and $70 a month, per every $100,000 borrowed, according to Freddie Mac.

The PMI rate depends on the buyer’s credit score and loan repayment terms. A higher credit score may yield a lower insurance payment, as it signifies to the lender that the borrower is responsible in making on-time debt payments. According to Policygenius, the monthly amount should remain fixed over the life of the loan, or as long as the borrower is required to pay.

Most commonly, the cost of mortgage insurance is tacked on to the monthly mortgage payments — along with property taxes and homeowners insurance — and paid to the lender, but there are other options, Policygenius explains. The homebuyer can pay the lump-sum insurance payment up front, though oftentimes it’s better to just put the money toward the down payment; pay part of the insurance payment up front, and part of it through monthly payments; or opt for a higher interest rate if the lender pays for the insurance up front.

After the homeowner reaches 20% equity in the home, they can apply to have PMI waived for the remainder of the loan. If a homeowner continues making the insurance payments and their equity reaches 78% of the original value of the home, the lender is required to cancel PMI.

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