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Your Down Payment

How large a down payment should I make?

Ideally, you should purchase a home and have enough accumulated for a down payment so that your down payment represents 20 percent of the purchase price of the property. Twenty percent down is the magic number because it's a big enough cushion to protect lenders from default.

If your down payment is less than 20 percent of the purchase price of the property, be aware that almost all lenders require you to obtain (and pay for) private mortgage insurance (PMI).

Although PMI typically adds several hundred dollars annually to the cost of your loan, it protects the lender financially if you default. You can also expect worse loan terms such as higher up-front fees and/or a higher ongoing interest rate on a mortgage when you make a down payment of less than 20 percent.

Suppose, for example, a buyer puts only 10 percent down, then property values drop 5 percent, and the buyer defaults on the loan. When the lender forecloses -- after paying a real estate commission, transfer tax, and other expenses of sale -- the lender will be in the hole. Lenders found they are far less likely to lose money on mortgages where the borrower has put up at least a down payment of 20 percent of the value of the property.

What is PMI or Mortgage Insurance?

If you buy the home and make a down payment of, say, 20 percent of the purchase price, the lender is putting up the other 80 percent of the purchase price. So if the home burns to the ground and is a total loss, the lender may care more, at least financially, than you do. In most states, your home is the lender's security for the loan.

Almost all lenders today require you to purchase private mortgage insurance (PMI) if you put down less than 20 percent of the purchase price when you buy.

Do I pay PMI or Mortgage insurance for the life of the loan?

PMI is not a permanent cost. Your need for PMI vanishes when you can prove that you have at least 20 percent equity (home value minus loan balance outstanding) in the property. The 20 percent can come from loan paydown, appreciation, improvements that enhance the value of the property, or any combination thereof. Note also that, to remove PMI, most mortgage lenders require that an appraisal be done -- at your expense.