Author: Dan Brown
As you start thinking about buying a home, the usual questions pop up. How much are you willing to spend? Where do you want to buy? His and hers sinks? And the big one—how much should you save for a down payment?
That will vary per buyer, but anyone coming in under 20 percent down will have to ask themselves one last question: what kind of private mortgage insurance should I get? Private mortgage insurance is what borrowers pay when they take out a residential mortgage with a down payment of 20 percent or less. PMI protects the lender in the event that the borrower defaults on the mortgage.
At the same time, PMI has earned an unfair reputation as “bad,” and to be avoided. Don’t believe the myth—paying PMI isn’t necessarily a bad thing. It allows buyers to purchase homes earlier, or to pounce on low interest rates. It also means that prospective buyers don’t need to exhaust their savings, which comes in handy after buying a home, especially during these times of uncertainty.
Let’s explore the ways you can structure PMI, and which one may be best for you.
Types of PMI
With FHA loans, there is no flexibility with PMI, it is all structured the same way. But with conventional loans there is the ability to customize the PMI to meet the clients needs. Just like with every other loan, the cost, or “rate”, of PMI varies depending on the risk of the buyer. Credit scores, loan to value, debt to income, and mortgage amounts all come into consideration. Those rates fall into three thresholds: what you pay between 5 to 9.99 percent down payment, 10 to 14.99 percent, and 15 to 19.99 percent. How and when you pay that rate, though, can vary.
The most common way to pay PMI is monthly, paid by you. When you look at your monthly statements, you’ll see your total payment, principal, interest, taxes, and insurance, and on top of those you’ll have your PMI. This is the default option; you pay it until your loan principal drops to 80 percent of the home’s value, when you reach 20 percent equity.
Another option is lender-paid PMI. In this scenario, your mortgage lender “pays” the insurance for you, in the form of a higher interest rate. This might technically mean a lower mortgage payment than if you chose monthly payments, but there’s a catch: lender-paid PMI doesn’t drop once you hit 20 percent equity. Your PMI is built into your interest rate.
Then there’s single premium PMI. This is exactly like it sounds: a one-time lump sum, upfront. This completely eliminates the PMI from your monthly payment, but obviously increases the out of pocket costs at settlement. Single premium PMI will result in a lower total monthly payment, and will cost less to pay the PMI in one lump sum than over time monthly, but there is a catch: if you sell the house in the first few years, that money is gone.
The option I’m most excited about these days is financed PMI. While this may not be the most common, and won’t work in all cases, it’s easy to see how it can pay dividends for savvy homeowners. In this option the borrower adds the amount of the single premium PMI to the loan amount. The benefit to financing the PMI is that you eliminate the monthly aspect of PMI without increasing your out of pocket costs. While rates are low, every $1,000 in your loan amount equates to roughly $5/month, so this is a nice balance between your monthly payment and your out of pocket expenses.
For example, say you’re in the market for a $300,000 home, have a 760 credit score, and will be able to put 10 percent down. If you opted for monthly PMI, it would cost $47.25 a month. If you chose financed PMI it would add $2,079 to their loan amount—which would add roughly $10 to your monthly payment—but would eliminate that $47.25 from their monthly payment, as well, dropping your base monthly payment by about $37.
With interest rates as low as they are, no one needs to save 20 percent for a down payment right now. And a little guidance can help you save on your PMI costs as well.
How We Can Help
At Kelly Mortgage, we ask five questions to all potential clients:
- The area where they’re hoping to buy
- Price range
- The monthly payment they’re comfortable with (this may differ from the maximum possible payment they qualify for)
- How much they’re willing to spend out-of-pocket between down payment and closing costs
- Their timeline
We ask these questions because the biggest thing we can provide is helping clients match their expectations to reality. The sooner we can do that, the closer we are to figuring out what plan will work best for you.
It’s important to remember that there’s no 20-percent down-payment requirement to purchase a home. And more importantly—especially considering the low interest rates available today—in many cases it can be financially beneficial to structure your mortgage with PMI and keep your savings. Please reach out to us if you have any questions.