Reduce Your Mortgage Downpayment
It’s an excellent time to be a buyer with less than 20% down to buy a home.
Mortgage lenders are making more low- and no-downpayment loans available to today’s home buyers; and purchase loan approval rates are markedly higher as compared to earlier this decade.
Freddie Mac’s weekly mortgage rate survey puts the average 30-year mortgage rate below four percent nationwide; and FHA and VA mortgage rates average even less.
For buyers with less than 20% down, though, there’s an added mortgage loan expense about which to be aware. It’s called Private Mortgage Insurance and it’s required on all conventional loans where the downpayment is less than 20% of the home’s purchase price.
Commonly abbreviated as “PMI”, private mortgage insurance is a required insurance policy which insures a lender against loss should a homeowner stop making payments on a loan.
PMI is not the same as FHA mortgage insurance premiums (FHA MIP), which are for FHA loans only. PMI is for conventional loans only.
PMI is neither “good” nor “bad”. However, it’s helped a lot of people to become homeowners who otherwise would not have qualified.
When Is PMI Required?
Private mortgage insurance is required for conventional home loans only. That is, loans backed by Fannie Mae or Freddie Mac.
Conventional loans are available via all major lenders including Wells Fargo, Bank of America, Quicken, JPMorgan Chase, and others; and are often made for loan sizes within local conforming loan limits.
When the downpayment on a home is less than 20%, PMI requirements kick in. PMI protects the lender in the event that the homeowner defaults.
To understand why PMI is required, consider what happens during a default.
When a default occurs, payments have already stopped on the home, for 3 months at minimum, which creates a loss for the lender. Sometimes, payments haven’t been made in 15 months or more.
Next, depending on the borrower’s circumstance, the home in which they’re living may have incurred damage and may include deferred maintenance, which can make a home uninhabitable.
Deferred maintenance items include roofing issues, structural damage, and the presence of mold, as examples.
So, by the time the home is eventually sold in foreclosure, the lender has incurred a real loss in terms of missed payments; and other losses related to the home’s condition.
A lender will typically lose twenty percent of a home’s value during the process of default and foreclosure. Hence, the requirement to put 20% down — anything less puts the lender at risk.
Private mortgage insurance covers lenders against loss. The smaller your downpayment, the larger the policy on the home.
The minimum required downpayment on a conventional mortgage is 3%, available via the Conventional 97 program.
PMI payments are higher for the Conventional 97 as compared to loans where the downpayment is five percent, ten percent, or more.
The Three Types Of PMI Coverage
As a homeowner, you have options for how you pay the private mortgage insurance required.
One option is known as “single premium”, in which you make a lump-sum payment at the time of closing which covers your PMI policy for as long as your mortgage is active.
A second option is “lender-paid mortgage insurance” (LPMI) which requires no monthly payment whatsoever, but for which your mortgage rate will be raised to offset the lender’s additional risk.
The third option is “monthly premiums”, which is the most common method by which homeowners pay PMI. The annual cost of insurance is split into 12 parts, and collected with each month’s mortgage payment.
In the PITI of a mortgage payment, mortgage insurance is the second “I”.
Each of the option has its merits.
Homeowners who plan to keep their current loan and expect home values to moderate or remain flat may prefer the single premium option, which may limit long-term costs.
By contrast, homeowners who intend to move or refinance within the first few years of the loan may prefer lender-paid MI, which raises the mortgage rate by a small amount, but which requires no separate payment.
For everyone, monthly premiums are likely the best fit. Payments are regular, then cancel out as the loan pays down over time and as the home increases in value.
Canceling Your PMI Coverage
Private mortgage insurance gets a bad rap.
Buyers have called it “stupid”, “a waste of money”, and worse. “I shouldn’t buy a home if I can’t afford 20% down”, they’ll sometime say.
But PMI serves a purpose.
PMI lets a buyer purchase a home with less than 20% down. The cash not used for downpayment can be used to finance home improvements; or to keep an emergency fund “stocked”; or for any other purpose.
The ability to access PMI also lowers the barrier-to-entry for many would-be homeowners.
Currently, the median U.S. sale price is north of $250,000 which means that, because of PMI and the Conventional 97 mortgage program, home buyers can eschew a $50,000 downpayment in favor of one as low as $7,500.
PMI is the price you pay for being allowed to make a downpayment of less than 20%.
Even better, private mortgage insurance is impermanent.
As a homeowner, once you can show that your home’s equity position has reached twenty percent, you reserve the right to ask your lender to have your PMI removed and, in many cases, your PMI payments can be canceled immediately.
A home with a loan-to-value of 80% or lower, after all, is a much smaller threat to the bank.
There are two ways by which your home equity can reach the required levels for PMI cancelation.
- Your loan balance is paid down to 78% of the home’s original purchase price. This happens with regular monthly payments to your lender, eventually.
- Request a home appraisal from your lender which shows at least 20% home equity
Lenders are required by law to cancel private mortgage insurance once either of the above options can be proved. However, consumers can also be pro-active.
As home values rise nationwide, U.S. homeowners are seeing their home equity percentages rise. And, meanwhile, mortgage rates continue to troll near four percent.
There are an estimated 6.5 million U.S homeowners currently eligible to refinance and many of them are currently paying PMI.
A new loan, which would require a new appraisal, may show the requisite 20% home equity required to ditch the PMI. In this way, homeowners can refinance their PMI away.
Posted August 12, 2015
in About Mortgages