Part 2 of 3- Avoiding Private Mortgage Insurance (PMI)

This part is for those who have yet to commit to a mortgage and have or are looking to start shopping for a home.  If you have at least 20% to put down on a home, or can legitimately get it before purchasing, do it!  If you want to pay your house early, not having PMI will get you there faster. If you want to have a lower monthly mortgage payment, not having PMI will save you thousands and allow you to either have extra cash in your pocket each month to use, or pay your mortgage off faster. Remember, PMI is not a good deal for the borrower other than it allows them to buy a home without having to put 20% down.  It is possible buying a home with PMI may be the only or best option when considering your circumstances.  Rent may be very high in your area and buying vs. renting may have lower monthly costs for you.  If you don’t have the 20% down payment, there are a few options that allow you to avoid PMI.

Option 1: Wait and aggressively save up the 20%

If you are nowhere near having the 20% down and have to buy a home tomorrow, then waiting won’t work. But if you are within striking distance of reaching it within a reasonable time horizon based on your circumstances, strongly consider it.

The average home price in the United States is in the $200,000 range. A down payment of 20% would put you at needing $40,000 down to avoid PMI. Everyone’s circumstances are different: current living situation, household income, rent v. buying monthly costs, risks of employment re-location, and ability to save large amounts of cash.

If you are still living with family at no or a super low cost and the situation is sustainable, consider taking longer advantage of that situation and aggressively keep saving up your down payment. Your ability to aggressively save is based on three factors: income, expenses, and your behavior/choices.  At the end of the day, your behavior is the driving factor.  Your personal finances are 80% behavior and only 20% financial. Combining the synergy of maximizing all three factors to save will speed up the process.

First, make a conscious and aggressive choice and effort towards reaching your financial goals.  Next, increase your income and decrease your expenses. Put off short-term rewards for long-term gain. For more on personal finance, I highly recommend following Dave Ramsey.  Check out of his book the Total Money Makeover. His radio show is available on Sirius XM radio, podcast form, and through the Dave Ramsey Show app.

If you are about to be married or in a relationship in which you will be cohabitating, consider renting together before buying.  Do not get wrapped up in the dream of buying a home together just because that is what people in society do. Do things that make sense to you, not what others think you should do.  The ability to save with your spouse or significant other (partner) greatly expands when you live together. I am not advocating you sacrifice your values and morality toward the ends of saving money. When you live with your partner, you can literally cut your living expenses in half.  Benefits include: one rent payment instead of two; one set of utility bills, combining auto insurance for a multi-policy holder discount, family cellular plan discounts, and several others. You can save well over $100 a month just by merging your auto insurance and cellular plans together.

Getting married?  Request your gift to be a check to go towards your down payment fund.  Average costs of a wedding hover around $30,000!  That’s for ONE DAY of your lives.  There is your down payment right there.  $30,000 saved is $30,000 earned. Put that directly into the equity you and your spouse have in your family home. That would save you $30,000 in principle/equity you have to pay back to the lender, about $25,000 in interest on a 30 year fixed rate mortgage at a 4.5% interest rate, and about $5,000 in PMI. Having a one-day experience for $60,000 dollars vs. an investment into your family home is a choice.  Neither choice is necessarily wrong or right, just be informed about the long-term consequences of your choices.

Option 2: The second mortgage or “piggy back” loan

A conventional mortgage will generally require a 5% minimum down payment.  Getting a first mortgage for 80% of the home’s value and a second mortgage (a.k.a. “piggy back” loan) for the balance, minus your down payment, will allow you to avoid PMI.  This can be a great tool in saving you money. Your interest rate on the second mortgage will likely be higher than that of your primary. Try to get mortgages (first and second mortgages) without pre-payment penalties.  Most mortgages do not have pre-payment penalties. This way, you can use the PMI savings and other funds to pay down the second mortgage early.  You never have to pay PMI and can divert the savings to benefiting you. As with all mortgages and loans, make sure you shop around for the best rates and terms. Not all lenders are the same and a 0.25% savings on your rate can save you thousands in the long run.

Option 3: Lender paid PMI

Lender paid PMI sounds great, but is not directly accurate.  What they do is offer a no PMI mortgage to borrowers with less than 20% down.  The lender then charges the borrower a higher interest rate than a borrower who has the 20% down payment. This may seem attractive at first, as the premium the borrower pays is only 0.2% more.  I recommend against this option. I would rather do option 1, 2, or get the mortgage with PMI and do a plan listed in part 3 of this PMI blog series.  But let’s see how that plays out over a 30 year fixed rate loan.

Lender Paid PMI Case Study on a 30 year fixed rate mortgage on $200,000 home

No Lender Paid PMI at 4%

-20% down ($40,000)

-$160,000 borrowed

-$763 Monthly principal and interest (P&I) payment

-$114,991 total interest paid over loan

Lender Paid PMI at 4.2%

-5% down ($10,000)

-$190,000 borrowed

-$929 Monthly principal and interest (P&I) payment

-$144,487 total interest paid over loan

What does the 0.2% premium you pay for Lender Paid PMI cost you?

-$166 more a month for all 30 years of the loan (about what your PMI payment would be for 9 years)

- $29,496 extra interest you pay over the course of the loan

There are scenarios based on your circumstances where this may be advantageous such as:

-You knew you would be in the home for less than 9 years

-You are confident you can aggressively prepay your mortgage and/or the home price appreciates AND you can refinance without PMI later at a better interest rate in less than 9 years. There are a lot of moving parts to this and issues beyond your control such as interest rates and home appreciation value. This would be risky without a crystal ball.

Part 3 of this blog series will cover how to get rid of PMI when you are already committed to a mortgage with it. Contact Paul at Paul@RealEstatePaul.com or visit RealEstatePaul.com for a free, no obligation consultation.