Hi, this is John from Downs Capital. In another video we talk about how you don’t have to put 20 percent down to buy a home. But when I tell people that, the very next thing they say is, but I don’t want to pay PMI. So what is PMI?
You know, in the old days if you wanted to buy a house you had to put 20 percent down. But then the idea was born for an insurance option that would cover that difference. Basically it would insure that top 20 percent of the loan for the lender. That way if for some reason the loan defaulted that insurance would minimize the bank’s loss. It was a win-win for the bank. They could make more loans and you pay for the insurance. And actually that sounds bad, right? But is it really? Your loan with a bit of PMI might actually be better than next year’s 20 percent down loan. Plus, once you’re in the housing market you’re building equity.
Let’s check this out on the whiteboard. If you’re putting less than 20 percent down you’re going to be paying a little more for that mortgage in some way. So let’s play the game of PMI. There are four doors. Which one do you choose? And which one is best for you? To shed light on that, let’s give an example of a $400,000 loan and let’s assume you’re putting 5 percent down and you have pretty good credit.
Option 1 is basically showing up on the settlement table and just writing a check for $6,600. You take that check, you give it to the insurance company and you don’t have to worry about PMI ever. Of course that sounds great, right? It does give you a lower payment, but unfortunately that insurance, it only protects that loan. What if you refinance? What if you move in a couple years? And the reality is most people just don’t have that money.
Option 2 is the one we’re probably all most familiar with and that’s the monthly PMI. That’s where you just look at your mortgage statement and you’ll see a line item, mortgage insurance. In this case, $183 a month increase to your payment. Of course one big negative is it’s not tax deductible. But a positive is, it does disappear once you reach a 20 percent equity position, which in this case is about seven and a half years.
Option 3 is the one that we see a lot of clients take advantage of. It’s basically where you incorporate that PMI, that $6,600 charge and you sort of roll it into your actual mortgage rate. Mortgage rate’s a little bit higher, but you see with the reduction or the removal of that monthly PMI, you actually save money, in this case 50 bucks a month. Of course when you start spinning in tax savings on top of that, the difference can be even bigger. In this scenario, could save about a thousand dollars a year by choosing Option 3, building it into the actual interest rate.
A lot of people have heard of these combination mortgages and that’s a way of totally working around paying PMI. The industry term for this is an 80-15-5. That’s where you finance 80 percent. You take one loan for the bulk of the money. And then the remaining difference is part your cash, the 5 percent, and then part second mortgage, the 15 percent. The benefit there could be quite a lower payment. But unfortunately it does add a little bit more risk, as second mortgages can have higher rates and typically an adjustable rate feature.
So you shouldn’t be so quick to say I don’t want to pay PMI. And I’m not saying that this is for you or that that one’s better or this one’s better. But what I’m saying is you should take a look at it. Take a look at every single option. That’s what I have to do for my clients. And then once you talk about those options and life, and markets you get tremendous clarity behind making a decision to see if that’s the right thing for you.
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