Mortgage Insurance (PMI), The Gift that Keeps on Giving

I wanted to take a moment to completely bore you this week and talk about something that many people hear about but don't necessarily grasp. And that is mortgage insurance.

[insert resounding yawn here]

Mortgage insurance sounds pretty boring, but it actually can cost people tens of thousands of dollars over the life of a loan. Here's how it works with a good summary from our friends at Bankrate:

"When a homebuyer makes a down payment of less than 20 percent, the lender requires the borrower to buy private mortgage insurance, or PMI. This protects the lender from losing money if the borrower ends up in foreclosure. PMI also is required if a borrower refinances the mortgage with less than 20 percent equity."

The Dirty Details

This stuff is expensive, which is why I recommend always dropping 20% down when you buy a home OR find a credit union that waives PMI with 10% down, the latter is pretty rare.

So how much is this going to cost you? Well, it can cost between 0.3% to 1.5% of the original loan balance per year. So let's say it's 1% on a $120,000 home.

1% of $120,000 is $1,200; PMI will be paid a monthly rate of $100/month. If you put 5% down on the $120k home, your payment will go from about $900 per month to $1,000 per month.

What if you put 20% down, you ask? Then your payment would only be $787.00. Much better, right?

How do I get rid of this ankle chain?

Generally you either (1) drop 20% at closing or (2) wait until you have reached 20% equity in the home. In the example above, that magic number is $100,000 (20% of $125k). However, you will need to obtain an appraisal and it's your responsibility to initiate this process contact with your lender once you've dropped below 80% loan to value (LTV). It's worth noting, some lenders prefer 78% LTV, because of the variability of the real estate market. 

This is important: IF YOU USE FHA or USDA LENDING, YOU CANNOT DISCHARGE THE PMI UNTIL THE MORTAGE IS PAID OFF BY EITHER A FINAL NOTE BEING PAID OR A REFINANCE UNDER A TRADITIONAL (CONVENTIONAL) MORTGAGE.

For you veterans out there, there is no PMI attached to your loan (VA) regardless of your down payment. Which is nice, but I still recommend 10-20% for the vets. It just puts you in a better position starting out. If the market tanks, then you still having equity to play with and if there is a bad financial circumstance, then you can sell. Basically, you want to leave yourself with as many options as possible.

I think a lot of people are captured by the allure of buying a home with no money down, but in actuality, it is never a good idea. There could be a lot of bad things that come about as result of not putting any money down on a home and all of it spells trouble.

Recommendations on Buying a Home

In Move #8 I talk about the steps for buying a home. Here they are:

1. Don’t let your payment, interest, taxes, and insurance total over 30% of your monthly net income. This isn't a hard and fast rule, it is just something to be mindful of. You don't want to wind up "house poor" and have all of your monthly capital going towards housing.

2. Put at least 10% down and have some money banked. You always want to go into a home with some equity. I strongly recommend 20% to avoid Private Mortgage Insurance (PMI), but I'll settle for 10%.

3. Survey the neighborhood. When my wife I first went home shopping, we called a local police department to get some information on an area of Lansing that we weren't familiar with. They were very helpful. Friends and co-workers are great resources too. You never want to move into a bad neighborhood. Make sure it's solid before you move!

4. Choose a smart mortgage. Adjustable rate mortgages (ARM) and other variable rate mortgages are very risky. The best types of mortgages are 15-year fixed and 30-year fixed rate mortgages. I would try for a 15-year mortgage if you can swing it!

5. Don’t be pressured. I hear people tell young couples who are renting that they need to buy a home instead of wasting their money renting. You may not be in a good financial position to purchase a home. Don’t succumb to pressure. You know what's right for you.

Overall, buying a home ought to take longer than it does to buy a TV or laptop. It’s a big purchase and a big responsibility.

Take your time and avoid PMI. Also, don't let your dopey lender talk you into PMI just because he or she thinks you need a house and says you're wasting money on rent. It's money you never get back.

Take care, all.