Do All First-Time Home Buyers in California Have to Pay PMI?

First-time home buyers in California typically have a lot of questions about the different requirements for a mortgage loan. Today, we will address one of the most common questions on this subject:

“Do all first-time buyers in California have to pay for PMI?”

What Is Private Mortgage Insurance?

PMI stands for private mortgage insurance. It is a type of insurance that protects lenders in the event that a borrower defaults on their mortgage.

Here are seven things every first-time buyer in California should know about PMI:

1. What PMI is: Private mortgage insurance (PMI) is a type of insurance that protects the lender if the borrower defaults on their loan.
2. When it’s required: PMI is typically required when a homebuyer puts down less than 20% of the home’s purchase price, resulting in a loan-to-value ratio above 80%.
3. Why it’s required: Lenders use PMI to reduce their financial risk on loans with smaller down payments.
4. The typical cost: In California, PMI usually costs between 0.58% and 1.86% of the loan amount annually, depending on factors like credit score and loan type.
5. How it’s paid: PMI payments are often included in the monthly mortgage payments, along with taxes and insurance. But they can also be paid upfront at closing, in some cases.
6. Ways to avoid PMI: Avoiding PMI typically requires a 20% down payment, a piggyback loan, or choosing a loan program that doesn’t require it, such as some VA loans.
7. How to cancel it: Homeowners with private mortgage insurance can request cancellation when they reach 20% home equity. Cancellation should happen automatically at 22% equity.

Do All First-Time Buyers in California Pay PMI?

Not all first-time home buyers in California have to pay for PMI. As mentioned above, this will depend on (A) the size of your down payment and (B) the loan-to-value ratio.

Let’s start by defining the loan-to-value ratio. In order to understand the PMI requirements for first-time buyers, you need to know how the LTV ratio is calculated.

The loan-to-value (LTV) ratio is a financial term used in lending that represents the ratio of a loan amount to the appraised value of a property. It’s calculated by dividing the amount of the loan by the value of the property.

• Example #1: If you buy a home in California valued at $400,000 with a 5% down payment, your loan amount would come to $380,000. So the loan would account for 95% of the property value. In this scenario, the LTV ratio would therefore be 95%.
• Example #2: If you were to increase the down payment amount to 20% for that same $400,000 home, you would end up borrowing $320,000. So the LTV ratio would drop to 80%.

When the LTV rises above 80%, as in the first example above, private mortgage insurance is typically required. This is true for both first-time and repeat home buyers in California. It’s an industrywide standard that applies nationwide.

Some Exceptions to This General Rule

First-time buyers can avoid paying PMI in several ways. Here are the three most common scenarios:

1. A down payment of 20% or higher

We’ve covered one of the avoidance strategies already. Borrowers who can afford to put down at least 20% on a conventional mortgage loan can keep the LTV ratio at or below 80%. An upfront investment of this size avoids the need for PMI, which means you don’t have to pay it at all.

2. Piggyback loans

Even if you can’t afford to make a 20% down payment, you could potentially avoid PMI by using what’s known as a piggyback mortgage strategy. This involves obtaining two loans simultaneously, hence the “piggyback” term.

For instance, the borrower might take out a first mortgage for 80% of the purchase price, along with a 10% second mortgage. The remaining 10% down payment is covered by the borrower’s own funds, in the form of a down payment.

With this strategy, neither one of the home loans (on its own) would account for more than 80% of the property value. So PMI would not be required in this case.

This is a common strategy for first-time buyers in California who wish to avoid the extra cost of mortgage insurance but cannot afford to put 20% down.

3. VA loans

VA loans for military members and veterans do not require PMI, regardless of the down payment amount.

In fact, a first-time home buyer who uses a VA loan to buy a house in California could finance up to 100% of the purchase price. And even in that scenario, there is no mortgage insurance requirement!

The federal government provides a partial guarantee for VA loans, which gives the mortgage lender an added layer of protection against default. Because of this, a first-time buyer in California could buy a home with no down payment and no mortgage insurance.

Borrowers who use the VA loan program do pay a one-time funding fee, which can be paid upfront or rolled into the loan. But the funding fee is less of a financial burden when compared to the recurring cost of PMI.

How PMI Benefits First-Time Buyers

While it does increase the size of your monthly payments by a moderate amount, PMI also brings some significant advantages for first-time home buyers. Here are the biggest benefits.

1. A smaller down payment

PMI allows you to purchase a home with a down payment of less than 20%, which can significantly reduce the amount of upfront cash that’s needed. Because of private mortgage insurance, eligible borrowers could get a conventional loan with a down payment as low as 3%.

2. A faster path to homeownership

By reducing the down payment requirement, PMI also helps first-time home buyers in California become homeowners sooner rather than later. It reduces the amount of money that needs to be saved and shortens the path to homeownership.

3. More homes to choose from

PMI enables buyers to purchase homes in more competitive markets or target specific neighborhoods that may have higher median home prices. This can be particularly beneficial for first-time buyers who have their sights set on a particular location or type of property.