What you should know about mortgage interest, PMI and down payments
Buying a home is exciting, but understanding the costs can seem confusing. Three important parts of a mortgage are the down payment, mortgage interest and private mortgage insurance (PMI). Learning how each one works can help you make smart choices and avoid surprises.
What is a down payment?
A down payment is the money you pay upfront when buying a home. It’s usually a percentage of the home's purchase price. For example, if you buy a $300,000 home and make a 10% down payment, you would pay $30,000 before taking out a mortgage loan for the rest.
Many people believe they need a 20% down payment to buy a home, but that’s not always the case. Some loan programs allow qualified buyers to put down as little as 3 to 5%. However, a larger down payment can lower your monthly mortgage payment and reduce the amount of interest you pay over time.
How does mortgage interest work?
Mortgage interest is the cost of borrowing money from a lender. Think of it as the lender's fee for giving you the loan. The interest rate is shown as a percentage, and it affects how much your monthly payment will be.
For example, if you borrow more money or have a higher interest rate, your monthly payment will typically be higher. On the other hand, a lower interest rate can save you tens of thousands of dollars over the life of your loan. Your credit score, income, loan type and current market conditions all play a role in the interest rate you receive.
What is private mortgage insurance?
Another cost some homebuyers face is private mortgage insurance (PMI). PMI is usually required on conventional loans when a buyer puts down less than 20% of the home's purchase price. While the homeowner pays for PMI, it protects the lender if the borrower stops making payments on their mortgage.
PMI adds to your monthly housing costs, but it also makes it possible for many people to buy a home sooner instead of waiting years to save a larger down payment. The amount you pay for PMI depends on factors such as your credit score, loan amount and down payment size.
When does PMI go away?
The good news is that PMI doesn’t last forever. Once you have built enough equity in your home, you may be able to have it removed. In many cases, homeowners can request PMI removal when they reach 20% equity, and lenders are generally required to cancel it automatically when the loan balance reaches 78% of the home's original value if the borrower is current on payments.
If your home's value has increased or you have made extra mortgage payments, you may qualify to remove PMI sooner. Contact your loan servicer to learn about the requirements for your specific mortgage.
Understanding the big picture
Understanding these mortgage terms can help you prepare for homeownership. A larger down payment can reduce your loan amount, a lower interest rate can save money over time and knowing how PMI works can help you plan for future savings. The more you understand before signing the paperwork, the more confident you can feel throughout the homebuying process.
Are you a first-time homebuyer in Memphis? Check out these programs that could make your homebuying experience even easier.