The average home buyer has been paying this much at closing, and that’s the problem.

If you’ve been thinking about buying a home, you know that it’s not that cheap these days. Not only are mortgage contract costs higher, but the continued shortage of real estate inventory has led to significant increases in U.S. home prices.

Typically, when you sign a conventional mortgage, you’ll be told that it’s a good idea to make a 20% down payment on the home. reason? If you don’t put down 20% at closing, you’ll face private mortgage insurance (PMI). Private mortgage insurance is an additional cost charged on top of your monthly mortgage payment (there may be other ways to pay PMI, but paying it monthly is the most common).

PMI may sound like additional protection, but don’t let the word “insurance” fool you. The purpose of PMI is to protect your mortgage lender if you fail to make your home loan payments when they are due. So, to avoid this, it is a good idea to try to put down 20% when purchasing a home.

Unfortunately, recent Realtor.com data shows that even though homebuyers these days are making larger down payments, many aren’t making more than 20%. This, on top of the generally high costs of owning a home, means that many people are facing PMI sentences.

What are buyers offering today?

Down payments on homes actually hit a new high in the third quarter of 2023, with a median down payment of $30,400, according to Realtor.com. A year ago, the average down payment was $27,300. The year before that it was $22,300.

However, a $30,400 down payment averages only 14.7% at closing. This is lower than the threshold needed to prevent PMI.

Why Avoiding PMI Benefits You

The good news about PMI is that you can eventually cancel PMI once you have enough equity in your home. But the bad news is that if you make a down payment of less than 20%, your PMI payments could be blocked for quite some time. And those extra costs can make an already large expense (owning a home) more difficult to manage.

PMI typically amounts to 0.5% to 1% of the mortgage amount. So, if you take out a $240,000 mortgage, your PMI could be $1,200 to $2,400 per year. This amounts to an additional $100 to $200 per month. Imagine spending extra money. above Mortgage payments, property taxes, maintenance and repair costs. There’s a lot to swing at.

Plus, if you put less than 20% down at closing, you’ll have less equity in your home to start with. If the housing market takes a nosedive right after you purchase your home, you could find yourself stuck with your mortgage. This means that the market value of your home is less than the amount you owe the lender. This can be problematic if you need to sell your home immediately, for example, to get a new job or deal with losing your job.

That’s why, if you don’t have enough money for a 20% down payment, you may want to consider buying a cheaper home or delaying homeownership. That’s not to say that paying PMI over a period of time is the worst thing in the world. But it’s an additional cost you can avoid by resetting some of your expectations about buying a home or sitting on it for a few months.

If you don’t want to do that, remember that you’re not paying PMI alone. However, please budget for those costs accordingly. Find out what your PMI is and make sure you can afford it on top of other homeownership costs.