Ready to buy your first home? While there are many factors involved in the home buying process, it’s crucial to first determine your budget. Knowing what you can afford before the search begins will keep you from falling in love with a home beyond your price range.

When financing a home purchase, the general rule of thumb is 20 percent down. What if you cannot contribute that much? It doesn’t necessarily mean you cannot buy a house. In these cases, private mortgage insurance (PMI) may be required by a lender.

What Is Private Mortgage Insurance?

Private mortgage insurance is typically added to the monthly payment on a conventional home loan when you have not put 20 percent down or the insurance can also be paid up-front. This type of mortgage insurance is to protect the lender in case a buyer defaults on the remaining balance and interest. The average cost of PMI is 0.5 to 1.5 percent of the annual loan amount.

Pros of Private Mortgage Insurance

Private mortgage insurance can be appealing for prospective buyers because it allows them to purchase property sooner. Rather than waiting until you can afford 20 percent down, you don’t have to miss out on your dream home. Plus, there are other associated costs to consider beyond the down payment. Private mortgage insurance may leave you with more cash on-hand for the closing costs, home inspection, attorney fees or any immediate repairs.

While you’re paying more each month, you start building equity sooner. When renting property, your money goes directly to the landlord but a mortgage payment helps to increase your home’s equity

If you have other debts, PMI gives you the opportunity to focus on paying off high interest student loans or credit card balances first, by making a lower down payment on a home.

Cons of Private Mortgage Insurance

Private mortgage insurance is not a necessary fee. If you’re able to afford 20 percent down, the lender won’t require PMI. Otherwise, let’s say you put down 4 percent on a $250,000 mortgage. Of the remaining $240,000, you could be paying an extra $1,200 to $3,600 a year.

While you may be eligible to cancel PMI once your mortgage drops below the 80 percent loan-to-value ratio, you may be required to submit an official cancellation request. After an appraisal, your request could be denied if home values have lowered in your area.

As the lender is taking on additional risk by accepting a lower amount of money upfront, PMI offers no protection to you. Unlike homeowners insurance, private mortgage insurance exclusively protects the lender.

To find out if PMI makes sense for your financial situation, speak with a mortgage originator at Ion Bank today!