It's getting easier to buy a home these days. Mortgage rates remain low, and many lenders offer mortgages with as little as a 5 percent down payment if you have good credit.
Lenders are typically protected from loss on mortgage loans by one of the government insurance programs, such as Fannie Mae or Freddie Mac. Or they require those with down payments of less than 20 percent to purchase private mortgage insurance to protect the lender against loss if the homeowner defaults. Private mortgage insurance makes it possible for many people to get a mortgage. But beware. PMI can be costly and tricky.
Here are five things you should know:
The cost of PMI depends on your credit, the amount of your down payment and the length of the loan
For example, if you put less than 10 percent down on a 30-year loan and have excellent credit, your monthly PMI will be 0.41 percent of the loan — roughly $35 per month per $100,000 borrowed.
A higher down payment of 15 percent could cut your monthly cost to $15 per month per $100,000 borrowed. And borrowing for only 15 years would result in a further cut in monthly payments.
Credit scores matter a lot. With a 780 score your PMI is 0.41 percent, and with a score of 700, the PMI percentage increases to 0.87 percent — a difference of $38 per month for every $100,000 borrowed.
If you're a veteran, you don't pay PMI
Veterans avoid PMI through the VA loan program. If you're a veteran you can get a loan with zero down payment, fixed for 30 years, currently at 3.25 percent.
PMI is not required after you have 22 percent equity in your home
Eventually, you will build equity in your home by making regular mortgage payments. Or the value of your home could rise, and a reappraisal after one year may determine that you have reached 22 percent equity.
PMI is supposed to “drop off” your monthly bill automatically when your equity reaches 22 percent. But you should keep track of the equity in your home, and you might even want to refinance when your equity rises to 20 percent.
The shorter your mortgage, the faster your equity rises. Typically with a 5 percent down payment, PMI payments last about 8.5 years on a 30-year fixed-rate loan. But the PMI will be paid off in only 3.5 years on a 15-year mortgage because you are building more equity with every monthly payment.
Even FHA mortages require insurance premiums, and this insurance may never go away
FHA loans carry federal mortgage insurance (known as MI), which is essentially the same thing as PMI. But on 30-year fixed FHA loan, MI never drops off and it carries a higher rate of 0.85 percent for buyers making a 5 percent down payment or less. But you can always refinance the loan as your equity grows. And an FHA loan may be your only option for getting a mortgage.
There are several ways to pay PMI
Usually, PMI is included in your monthly mortgage payment. But some lenders will “wrap” the monthly payment into a slightly higher interest rate on your mortgage. Since mortgage interest is deductible, this gives you a bit of an advantage. And some lenders will give you a discount if you pay the entire PMI up front in a lump sum. It's an enticement but wasted money if you sell the home before reaching equity of 22 percent.
My mortgage expert, Daniel Chookaszian of Perl Mortgage, who gave me these examples, reminds me of one other advantage of putting less money down and paying PMI. He notes that you can keep the cash that doesn't go into your down payment for emergencies, or even for retirement investments.
But I hope your goal is to build equity and escape PMI payments. That gives you security that is priceless. And that's the Savage Truth.
Terry Savage is a registered investment adviser. She responds to questions on her blog at TerrySavage.com.