BOULDER – Many potential home buyers state that a lack of savings is the biggest obstacle in their dream of home ownership, and it’s easy to understand why. A 20% down payment is the universally-accepted benchmark, which can be very intimidating when you look at some of today’s real estate listings. While it’s true that 20% (or more) will get you the most favorable terms, you shouldn’t give up on buying a home based on this number alone. It is absolutely possible to achieve the dream of home ownership with a lower down payment. If it appears that you will be going this route, you will need to understand private mortgage insurance, which is required for any home purchase where the buyer has less than 20% equity in the property.
Private mortgage insurance (PMI) is a policy that protects your lender if you ever stop making payments on your loan. There are two ways that lenders will handle this kind of insurance policy. One is referred to as borrower-paid mortgage insurance, and the other is known as lender-paid mortgage insurance. Don’t let the names fool you. In either case, you are the one who pays for the policy. It is simply a different payment structure.
Borrower-paid mortgage insurance
Borrower-paid mortgage insurance is probably exactly what you expect when you think of PMI. This is the added expense that is built in to your monthly payment. Borrower-paid mortgage insurance is often recommended to those home buyers who plan to live in the home for many years. It makes the most sense, because once a certain amount of equity has been reached and you have made your payments on time for at least 2 years, this type of PMI can be dropped. Equity may be increased in two ways: appreciation and paying down your principal balance by making extra payments. Once you are sure you meet the requirements, you will work with your lender directly to have the PMI dropped. The lender will approve your application if you can document at least 25% equity after appraisal. Otherwise, the amount will decrease automatically after you have made payments on your PMI for 120 months. The result is a significantly lower monthly mortgage payment.
The key disadvantage to borrower-paid premiums is that the buyer will have to be able to build the amount into their budget. When determining your ability to afford your loan, your lender will calculate the total housing payment, which includes mortgage interest, principal, taxes, homeowner’s insurance and mortgage insurance. For some borrowers, that additional insurance payment can make it more difficult to qualify for
Lender-paid mortgage insurance
With lender-paid mortgage insurance, your lender prepays for the policy on your behalf. This payment is made in a lump sum at closing, and the expense is passed on to the borrower in the form of a higher interest rate. This type of PMI is recommended for buyers who plan to live in their home for less than 10 years or those who have a very short term loan. The reason that this structure is not recommended for long-term owner-occupants is that it cannot be dropped. Lender-paid mortgage insurance will remain effective for the life of your loan, even after you have reached 20% equity.
Some buyers prefer this method because they want a lower monthly payment (or more house for the same monthly payment). The disadvantage is that it adds an average of 0.25% – 0.75% to the borrower’s interest rate, which is often a pretty sizable amount when you figure it over the life of a loan.
The amount you pay for private mortgage insurance, whether borrower-paid or lender-paid, is largely dependent upon your personal credit history, the qualification criteria for your loan, and the amount you are able to invest as a down payment. Because these are such variable factors, it pays to speak with an expert about the pros and cons of all loan scenarios (not only those requiring PMI). Educated borrowers will typically compare both options as well as consider the current market they are buying in and potential for appreciation when deciding which option is best. If you are interested in learning more about your mortgage options, call 303.579.5517 or e-mail [email protected].
Michaela Phillips is the Vice President of Mortgage Lending at Guaranteed Rate, Inc., the 8th largest retail mortgage company in the country. Since entering the mortgage industry in 1994, she’s consistently been a top producer. Being a VP at Guaranteed Rate offers many advantages to her and her clients including unparalleled customer service, efficiency, and most importantly competitive rates. NMLS: 312874.
By Michaela Phillips, Guaranteed Rate, Inc.