You don’t NEED 20% down to purchase a home
Forget what your parents told you. Ignore old internet articles that further spread this misinformation. Is a 20% down payment on a home ideal?
Yes. It’s right up there with having no credit card debt, and owning a reliable older car free and clear. It’s nice, but far from a lot of people’s reality.
Private mortgage insurance (PMI) is not a punishment, and it’s not as expensive as many think. It’s a tool meant to get you into a historically appreciating asset (a home) before inflation eats away at your savings.
What is Private Mortgage Insurance (PMI)?
Private mortgage insurance (PMI) is required on Conventional loans that do not have a 20% down payment. It is offered via third party companies unrelated to your mortgage lender.
If your mortgage down payment is only 3% to 5%, then you will need to purchase private mortgage insurance that will cover the additional 17% to 15%. This way, the lender is only risking lending on 80% of the loan amount by extending credit to you. If it ever has to foreclose on your home, a significant loss is less likely.
At the time of this writing, there are 6 private mortgage insurance (PMI) companies operating in the U.S. Market:
- Arch Mortgage Insurance Company
-
Enact Mortgage Insurance Corporation (formerly Genworth Mortgage Insurance Corporation)
-
Essent Guaranty, Inc.
-
Mortgage Guaranty Insurance Corporation (MGIC)
-
National Mortgage Insurance Corporation (National MI)
-
Radian Guaranty Inc.
Your mortgage company of choice may shop around to find the lowest premiums, or they may prefer using one PMI company over the others. Using a mortgage broker like myself generally means that they’ll not only shop around for the lowest interest rates for you, but also the lowest private mortgage insurance premiums when applicable.
You can email me for a private mortgage insurance quote on your specific scenario at [email protected].
If you are in the position to save money by not paying mortgage insurance, then that is the obvious choice. But don’t waste money renting instead of building equity, while home affordability is slipping away.
While you pay rent and try to save for that 20% down payment, homes in Utah are increasing in value by an average of at least 5% every year.
Don’t get me wrong, saving money is a great habit to get into! But turning your expenses (rent) into an investment (homeownership) is a work of financial art!
The minimum down payment on a Conventional Loan is 5% (even as low as 3% in some cases). The down payment on an FHA government loan it is 3.5%, while military VA loans and USDA rural loans offer 100% financing.
If your credit score is on the lower end, then an FHA loan would probably be better for you .
FHA loans are great for people with not so perfect credit scores, while Conventional loans are great for credit scores over 700.
If you’re renting a house around the $250,000 value and are paying close to $1,400 a month in rent, why would you postpone buying it in order to save anywhere from $100 – $200 a month?
By becoming a homeowner, you have the perks of:
- Building equity by having a portion of your payment applied to the principal balance owed
- The benefit of deducting mortgage interest on your tax return (rent is not tax deductible as you well know)
- Seeing your home steadily rise in value over the years.
Did I mention that for lower income borrowers there even down payment assistance programs intended to promote homeownership??
On to the good stuff.
How to get rid of Private Mortgage Insurance (PMI)
With FHA loans you’re a bit stuck, unless you put down 10% or more when you purchased your FHA mortgaged home. In that scenario, FHA mortgage insurance will “only” be in place for 11 years.
For most people, getting rid of the FHA mortgage insurance requires them to refinance their existing FHA loan into another loan type – preferably by obtaining a Conventional mortgage.
On a Conventional loan, BY LAW, you can request your lender to drop the private mortgage insurance (PMI) once you reach 20% equity in the home.
- this is based on the lower of your purchase price or home appraisal value at the time of the loan origination
- the request can be denied if you have late mortgage payments.
For example, let’s say you bought a home for $500,000, with 5% down, and the purchase price matched the appraisal value. Once your loan balance reaches $475,000 (which is 80% of the initial purchase price), you can ask for the private mortgage insurance to be removed.
I’ve heard of loan officers from local banks telling borrowers that they have to wait at least one year EVEN if they made extra payments to bring their loan down to 80% of the initial purchase value. Don’t accept this answer.
Point them to this official article on the CFPB website:
- “You can ask to cancel PMI ahead of the scheduled date, if you have made additional payments that reduce the principal balance of your mortgage to 80 percent of the original value of your home.”
If you come into a chunk of money, you can apply it towards your principal loan balance at any time, and follow with a request to have private mortgage insurance (PMI) removed.
If you don’t ask, lenders still have to remove the private mortgage insurance by law once your equity reaches 22% (also known as 78% loan to value).
If you’re dealing with a really difficult bank that refuses to remove the private mortgage insurance, you might need to refinance and take your business somewhere else. Or look into filing a complaint with Utah DFI.
Note that a new appraisal MIGHT be required to insure that the property value hasn’t dropped since the loan was first originated. DO NOT order an appraisal before talking to the lender, expecting them to use it. Your lender will have a list of approved appraisers that they will randomly assign.
Sometimes letters from 3 different real estate agents regarding current value of the property MIGHT BE ACCEPTED instead of an appraisal. Check if that’s an option in your situation.
Alternative, not so straight forward options of removing PMI
ASKING TO USE A NEW APPRAISAL
Let’s say you make a 5% down payment, and you buy a house that already has 5% equity because you got such a good deal. At that stage, the lender won’t care about the instant equity when doing your loan. Mortgage guidelines specifically state that the loan to value is calculated based on the lower of the purchase price AND/OR the appraisal value.
So your loan to value will be 95% (5% equity) at the time of the loan closing, even if using the appraisal value it would put it at 90% loan to value (5% down payment + 5% instant equity).
At least two years have passed, and you’ve made all your payments on time. The home has gone up in value by another 10%. If you were to have a new appraisal, you could now easily show 20% equity, and could request that the private mortgage insurance (PMI) be removed.
The current lender is still going by the original loan to value, so on paper, you only have about 15% equity (since your loan balance has also gone down a bit with the regular mortgage payments).
Disregard any suggestions to starting a refinance – especially if the current mortgage interest rates aren’t more favorable – and do this instead 👇
Contact your lender. Tell them you’ve been great about making your scheduled mortgage payments on time plus some extra payments here and there. And that your home value has increased significantly.
You’d like to have a new appraisal done to remove the private mortgage insurance (PMI) on your loan. You have a copy of the original appraisal if they want, showing you had instant equity at the time of the purchase. Put it in writing if possible, and give them time to process. They should play nice.
I’ve had borrowers successfully drop their mortgage insurance this way, and the lender has never told them no. Hopefully you won’t be the one to break that streak.
RECASTING YOUR LOAN
A lot of lenders out there will offer the recast or re-amortization option. This means you can submit a recast request and with it, send a chunk of money to lower your principal loan balance. If approved, the lender will apply the “recast” amount, and re-calculate your monthly mortgage payment based on the new lower principal loan balance, but the same remaining loan term and mortgage interest rate.
Please note that different lenders have different recast minimum amounts and they might limit how many you can do in a year. There is usually a small fee associated with a recast, maybe around $300/request.
Here is an example:
Let’s say you’re in the process of selling your current home and buying a new one. Your old home won’t sell before you have to close on the new home, but you qualify for both payments, and decide to only make a 5% minimum down payment on the new mortgage. You new mortgage will therefore have private mortgage insurance (PMI). You close on the new loan.
Your old home sells, and nets you $200,000 worth of profit.
You can now talk to your new lender, and ask for a recast, as well as the removal of the private mortgage insurance (PMI). $200,000 gets applied to your principal loan balance, and it decreases the amount you owe. You keep the same interest rate, but now have a re-amortized lower monthly payment, and no PMI.
You celebrate, then get back to the dreaded moving process.
*DISCLAIMER
Please note that all this information is based on my client experiences, and may not apply to all lenders. It’s always good to discuss you plans beforehand with your mortgage professional, and make sure that everything you want to do is doable.
This advice should be helpful to those of you who would prefer to hold on to their current mortgage rates. For everyone else, feel free to inquire if a mortgage refinance makes sense. Depending on your current interest rate, you might be able to save by both removing private mortgage insurance (PMI) AND by lowering your mortgage interest rate.
For questions or a detailed quote on a specific scenario, please email me at [email protected].
If you’re looking to start a refinance, please apply online – I usually review them within 24h.
