In a conventional mortgage, you’ll be required to put down at least 20 percent when buying a home. However, many people are unable to produce the full 20 percent, particularly in Houston where the average home price is $300,000, well above the national average.
Thankfully, there are programs and opportunities for taking out a mortgage with a down payment of less than 20 percent. You can apply for an FHA, VA, USDA, Fannie Mae, or Freddie Mac loan. There’s also the 97 conventional loan, which requires a down payment of just three percent.
These options will enable you to purchase a home despite a smaller cash contribution, but you’ll be required to take out a private mortgage insurance (PMI) policy. Before signing the papers, you should understand exactly what PMI is and how it will impact your 30-year mortgage.
Private mortgage insurance is typically referred to by its acronym, PMI. It’s an insurance policy that protects you from defaulting. If you miss a payment, your insurance will kick in and cover the costs.
It’s important to note that PMI is designed to protect the lender, not you. Your credit score will take a hit if you miss a payment and missing too many can lead to your bank repossessing your house. It only ensures that the bank gets their money every month, but you’ll still have to deal with the consequences of missed payments.
PMI costs vary based on your location, monthly payment, mortgage program, and your lender. You can figure out an approximate cost of PMI on your own mortgage by discussing with your lender, but it helps to look at an average at the beginning.
Dave Ramsey calculates that the average homeowner buying a $200,000 home will pay about $2,000 per year in PMI. By these calculations, you can estimate that a yearly premium will cost one percent of your entire mortgage amount. This is split into monthly payments, so you don’t necessarily notice the damage, but it adds up quickly.
There are lots of expenses that go into your monthly mortgage payment, but you don’t have to worry about them individually. Your mortgage lender will charge you the cost of your PMI policy, homeowner’s insurance, and any other fees along with your principal payment. Sometimes you’ll pay both upfront costs, such as at the time of closing, along with monthly payments.
Your lender will put the extra funds into an escrow account, which is a protected savings account that’s used to hold your money until they can transfer it to the appropriate entities. All you have to do is write a single check each month, and your lender will take care of the rest.
Avoiding PMI is ideal since it lowers your monthly payments and overall investments. Making a down payment of at least 20 percent of the principal is the easiest way to avoid it.
If that’s not possible, you might be able to take out a small loan to cover your down payment, circumnavigating the need for PMI. Of course, you’ll be saddled with a higher interest rate, but it may be more affordable to take this route.
Typically, PMI is only required until you’ve built 20 percent equity into your home. Your lender may not notify you of this option because they want you to continue your policy, so keep an eye on your principal and request to drop the PMI policy once you’ve reached 20 percent. When you reach 22 percent equity in your home, your lender is legally required to eliminate PMI.
Refinancing your home may also enable you to cancel your PMI policy. Begin the refinancing process when you’ve built a decent amount of equity into your home and mortgage rates are low. Your home must have gained substantial value since you originally applied for a mortgage. If you can establish that you owe less than 80 percent of what your home is worth, the bank should refinance and remove PMI.
PMI is typically not a big deal, especially if it means the difference between being approved for a mortgage and continuing to pay rent that you’ll never get back. Borrowers should consider their options carefully before choosing a loan that requires PMI.
The biggest benefit of PMI is that it helps you qualify for a loan that you might not otherwise be able to get, whether because your credit score is too low, or you don’t have a large cash down payment.
The biggest downside is that it increases the overall cost of your loan. You’ll usually pay a higher interest rate for loans that require insurance, and your monthly premium payments don’t build any equity. It’s money you won’t get back.
Ask your tax advisor if taking out a loan with PMI is a smart financial decision. You’ll likely discuss the length of time you plan to stay in your home, your current interest rate, and other potential options.
If PMI seems like a bad option, your financial advisor may recommend continuing to save for a better down payment. With time, you can qualify for a conventional mortgage without the burden of PMI.
We can’t help you get out of your monthly PMI payments, but we can make every other aspect of buying, selling, or managing a property easier. Our team of realtors and property managers know the Houston area better than anyone else. We have decades of experience providing top-notch service and real estate knowledge to our loyal customers.
If you’re an investor, buyer, or seller, we’ll help you complete your real estate transactions at a flat fee, saving you money on commissions. If you’re investing in a rental property, we’ll also manage it for you. We can screen tenants, run applications, collect rent, perform evictions, write lease agreements, keep up with the maintenance, and more.
If you’re investigating real estate in the Houston area, we’ll be there for you. For more information about services and pricing, contact us today!
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