Why has 20% down/80% LTV been the historical standard to avoid PMI?

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I know that lenders love it if you can put more than 20% down, but are willing to lend to those with <20% down if you buy PMI. But why is 20% down the standard cutoff point to avoid PMI? Why isn’t this ratio set higher at 25% down or 15% down? Why is 20% such a special number?

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3 Answers

Anonymous 0 Comments

Because of the risk involved. Statistically, homeowners with 20% or more equity in their homes are less likely to go into default, walk away from their mortgage, or attempt to short sell the home.

Anonymous 0 Comments

Most mortgage loans in the US are underwritten to the standards of Fannie Mae or Freddie Mac, which are the ultimate buyer/securitizers of most residential mortgage loans. They are required by law to only make high LTV loans (above 80%) if the loans have PMI.

Anonymous 0 Comments

It’s all a matter of risk profiles, which I won’t go into detail here with, but essentially, it boils down to –

How likely is it that someone will decide to quit paying and run off, abandoning the property? When you own 5% of it, it’s not all *that* expensive to decide “fuck it, let the bank try to take it”. 20%? Well now you’re talking about real money, a substantial investment.

How likely is it that prices change? Well, from year to year values can fluctuate. Odds are pretty decent that outside of extreme situations, the value of a house could be +/- 5-10% compared to the previous year.

Much less likely for a house to be worth 20% less next year than this year.

So, basically, it’s unlikely that either someone will walk away from a house they own 1/5 of, and also unlikely that it suddenly drops in value by 20%, so the bank (really, FNMA and FHLMC) is confident that they don’t need to insure the mortgage against default.

Also, they’re generally not allowed to require you to have it below 80% LTV, and must remove it below 78% except in specific cases, by law (HPA, 1998)