Published in: Mortgages | June 1, 2020
By: Dana George
If you don't have 20% to put down on a house, don't worry. There are times when it's better to pay for private mortgage insurance.
You may have heard that you should not buy a home until you can put 20% down. To that well-worn piece of advice, we say, "Not so fast." Sometimes, paying private mortgage insurance (PMI) can make sense.
PMI is an insurance policy that protects the mortgage lender if the borrower stops making payments. The reason people are so against it is that PMI protects the lender, but does nothing for the borrower.
You generally only need PMI if you're taking out a conventional loan and can't make a 20% down payment. And though it's impossible to say precisely how much PMI will cost until you take out a mortgage, you will typically pay between 0.5% and 1% of your loan amount annually.
It's also worth knowing that you don't have to pay PMI forever. The lender must drop it automatically once your loan balance is 78% of the original cost of the property. If your home appreciates in value quickly, you can request the lender drop PMI once your balance hits the 80% mark. You will need to pay for a home appraisal, but should quickly make that money back.
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The reality for millions of American homebuyers is that they don't have enough cash to make the full down payment. That doesn't mean they shouldn't buy a home, though. Here are three situations in which it may be okay to pay PMI.
It might be wise to lock in a home loan while rates are low, even if you don't have 20% to put down. Let's say you have your eye on a $200,000 house and the interest rate is a low 3.25%. You don't have 20% ($40,000) saved, but you do have 10% ($20,000).
Cost of mortgage with PMI: You take a 30-year mortgage and put 10% down and you are charged 0.5% PMI. It takes approximately five and a half years for your balance to reach the necessary 78% to drop PMI. That brings your monthly payment down from $858 to $783.
|3.25% With PMI||Monthly Payment||Total Payments|
|Mortgage (interest and principal)||$783||$281,880|
|PMI (for 62 months)||$75||$4,650|
|Total||$858 then $783||$286,530|
Cost if you save 20% down: You decide to save another $20,000 and avoid PMI. You put $500 into a house fund each month for 40 months, but by the time you get back to house hunting, the interest rate is 5.25% on a 30-year mortgage. You find another home for $200,000 and borrow $160,000.
|5.25% Without PMI||Monthly Payment||Total Payments|
|Mortgage (interest and principal)||$884||$318,240|
Your monthly payment is $26 more than it would have been if you had purchased a home when the interest rate was lower, and a full $101 a month more than it would have been once the lender dropped PMI. Plus you'll pay over $31,000 more in total and it will take you over three years more to become mortgage-free.
Entry-level homes are the first to be snapped up by first-time buyers and real estate investors. Low inventory leads to higher prices, which can push you right out of the market. Unless you're planning to relocate, your best bet may be to crunch the numbers and see if it makes sense to buy before you're in a position to put 20% down.
For example, Realtor.com recently predicted an 8.1% jump in home prices in Boise City, Idaho. Granted, that was weeks before the novel coronavirus locked everything down, but if the prediction proves accurate after house-hunting restrictions are lifted, Boise City is poised to be a red-hot market. If you hope to buy in an area where prices are on the rise, it might make sense to jump in before they go any higher.
If you have high-interest debt, your money may be better spent paying it off and dealing with PMI. Let's say you're looking at that 30-year mortgage on a $200,000 home at that same great 3.25% rate. You have money put away for a 20% down payment, but also carry a balance of $10,000 on a credit card with 21% interest.
Debt repayment with no PMI: You put all your savings down on the house and make a $200 payment on the credit card each month. It takes you 10 years to pay off the card and you pay a total of $14,000 in interest.
|Mortgage + Debt||Monthly Payment||Total Payments|
|Mortgage (interest and principal)||$696||$250,560|
|Debt (10 years)||$200||$24,000|
|Total||$896 then $696||$274,560|
Debt repayment with PMI: You use $10,000 to pay off the high-interest credit card. After making a $30,000 down payment, you are left with a $170,000 mortgage, and the PMI runs around $71 per month. It takes approximately 34 months before you can drop PMI, costing you a total of $2,414. That's $11,586 less than you'd pay in credit card interest.
|Mortgage + PMI||Monthly Payment||Total Payments|
|Mortgage (interest and principal)||$740||$266,400|
|PMI (for 34 months)||$71||$2,414|
|Total||$811 then $740||$268,814|
You'll save money by paying off that high-interest debt first and you could also snag a better mortgage rate by lowering your debt-to-income ratio (DTI). Similarly, if you don't have an emergency fund stashed away to cover three to six months' worth of bills, that should be your priority -- even if it means you have less to put down on a house.
Times change, situations change. It's okay to change with them. Avoiding PMI is often logical but there are some circumstances when it may not make financial sense for you.
Chances are, mortgage rates won't stay put at multi-decade lows for much longer. In fact, the Fed has already signaled that it expects rates to continue increasing. That's why taking action today is crucial, whether you're wanting to refinance and cut your mortgage payment or you're ready to pull the trigger on a new home purchase. Click here to get started by scanning the market for your best rate.
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