Private Mortgage Insurance an Option When 20% Down Payment Isn’t
A penny saved is a penny earned. We’ve all heard that saying at one point, maybe when Grandma sent us birthday money in a card or when Mom or Dad were teaching us about the importance of money management when we were little. Although this may have been true at one time, if we earned a penny for every penny we saved, well, I think we all would be saving quite a bit more than we do.
Part of the home buying process is the requirement to have a down payment (saving). Banks typically want you to have 20% of the purchase price as a down payment. Why? Put simply, a down payment lessens the risk the bank takes in loaning you the money. The thinking is that when a borrower puts 20% down, there is less chance of them defaulting (not paying) on the loan and the greater chance the Bank will get repaid.
To have a 20% down payment on a prospective home with a purchase price of $150,000 you would need to have saved $30,000. How do you get $30,000? Well, if you save $500 a month in a one-year period you would have $6,000 saved. But at that rate you would need to save for five years in order to come up with the down payment. Do you have that kind of time?
Let’s say you do: Five years go by, you’ve saved $500 every month and now have $30,000 for your purchase. The only problem is that the $150,000 home that you’ve been saving for is now $173,000 due to yearly appreciation of home prices at roughly 3% a year. That means your $30,000 down payment doesn’t buy the $150,000 house you hoped for five years ago. You’ll need an additional $4,600 to meet the 20% down payment requirement because the same house is now $173,000.
While you have been saving the last five years for your down payment, you’ve also been renting. At $900 a month for rent (given that rates didn’t increase) you’ve paid $54,000 in rent while trying to save $30,000 to buy your own home! This is money that you’ve been giving your landlord, and not building your own equity with. Although your landlord appreciates your business, you’d like your money to work for you.
So, how can you get into a home today with less than 20% down?
The Answer: Private Mortgage Insurance (PMI)
PMI offers qualified buyers the ability to purchase a home with less than 20% down.
A borrower pays for PMI on a monthly basis in exchange for a lower down payment. Auburn Savings Bank will allow a qualified borrower to purchase a home with as little as 5% down with PMI. PMI is an insurance policy you pay for that helps the Bank recover some losses in the event you can’t make your payments. . Just like other insurance policies you have, they provide coverage when an instance occurs.
With PMI, your $150,000 home purchase would now only require $7,500 for a down payment (based on Auburn Savings Bank’s 5% down payment requirement). $7,500 is more easily attained than $30,000, allowing you to start building equity in your own home now.
Do I pay PMI forever?
PMI doesn’t last forever. Once you have an 80% Loan to Value (LTV) ratio you can request that PMI be cancelled.
LTV is calculated by taking the principal amount that you owe on your loan and dividing it by the value of the home at the time you purchased.
Say you owe $130,000 on your loan against the home that you purchased for$150,000. Simply take what you owe ($130,000) and divide it by the purchase price ($150,000). That gives you your Loan to Value (LTV) percentage (86.6%). In this example, your LTV is still higher than 80%, so PMI is still required. However, if you owed $115,000 on the $150,000 purchase price of the home, your LTV would be 76.6%, which does not require PMI. When your LTV is 80% or less, contact your bank’s loan servicing department to determine if the requirements to remove PMI have been met. Know that by law, when your LTV reaches 78%, PMI must be automatically cancelled.
PMI is a great way to get into a home without a large down payment, but there is some risk a borrower needs to consider too. Our scenario assumed that home values grew at an annual rate of 3%. During the recession in the late 2000s however, housing prices dropped and many borrowers found themselves owing more on their home than what it was worth. How did this happen? Unfortunately, some borrowers started with a smaller down payment that, combined with falling home values, turned them as we say, upside down. Falling home values are scary for new home buyers, but staying the course and given time, values typically rebound. Like any investment, take the time to know what you are buying and make sure it fits your budget. You should always seek out financial advice from a mortgage lender to make sure that the timing of home purchase is right, or if a few extra months of saving are worth the extra wait.
Options for potential home owners
Even though a penny saved no longer feels like a penny earned, you can start saving for a purchase of a home today. $500 a month is an aggressive number, so rest assured that just because you don’t have 20% down today, doesn’t mean that you can’t buy a home. PMI gives you an option of being a home owner sooner. If you’re considering buying a home or want to know if PMI may be the right choice for you, contact us today to discuss your financial situation. Start thinking about building equity in your own home today.
Brian M. Judkins
Assistant Vice President &
Retail Development Officer