Private mortgage insurance is the key to a lower down payment.
Some renters give up their dreams of owning a home simply because they don’t believe they have enough cash for a down payment. But with private mortgage insurance, or PMI, mortgage lenders are more willing to hand over the keys to cash-strapped buyers.
What Is PMI?
PMI is required by a lender when a buyer puts down less than 20 percent of the appraised value or sale price of a home. The lender typically chooses the PMI provider, but the homebuyer is responsible for the premium. The PMI provider pays the lender in full if the buyer defaults on the loan. Government programs, including FHA and VA, also offer mortgage insurance.
Who Benefits?
With PMI, the lender avoids the risk of default while the homebuyer may be able to buy sooner or choose a larger home. A 20 percent down payment on a $300,000 home would be $60,000 while a buyer offering 3 percent down would need just $9,000. PrivateMI.com claims that PMI has helped 25 million Americans buy homes.
Costs
Because the buyer is putting down less money upfront, he’ll need to take out a larger loan. On a $300,000 home, the loan amount would be $291,000 with 3 percent down versus $240,000 with 20 percent down. The buyer will pay interest on this higher amount for the life of the loan. The buyer will also pay a monthly PMI premium. According to Bankrate.com, the cost of PMI depends on the down payment and loan terms, but it’s usually around .5 percent of the loan. According to GoodMortgage.com, a homeowner who takes out a 30-year loan for $291,000 at 5 percent would pay about $238 in monthly PMI premiums. Some lenders allow the buyer to pay the full PMI premium upfront along with other closing costs.
Avoid PMI
Bankrate.com suggests two ways to avoid PMI. First, look for a lender willing to waive the PMI requirement in exchange for an interest rate that’s 3/4 to 1 percentage point higher. Some buyers also choose 80-10-10 loans, putting 10 percent down then securing one loan for 80 percent of the sale price and a second loan for the remaining 10 percent. The second loan typically has a higher interest rate, but Bankrate.com says the total monthly payment for the two loans may still be less than a single loan that includes PMI. In both cases, the buyer may be at an advantage because mortgage interest is tax-deductible while PMI premiums are not.
Cancel PMI
Homeowners can cancel their PMI once they’ve reached 20 percent equity. The Motley Fool cautions that the 20 percent threshold applies to the home’s appraised value and not the loan amount. If the buyer got a great price for the home, fixed up an older home or found a neighborhood where property values are increasing, it may take longer to reach this threshold. Nevertheless, PrivateMI.com notes that 90 percent of borrowers are able to cancel their PMI within five years.
