Real estate prices are hovering at levels we haven’t seen since around 2006, or right before the real estate bubble. Many people are saying now may be a good time to buy a house, and for may people it is – provided they are prepared for it. The Wall Street Journal has a great resource for people who think they may be ready to move out on their own. Some of the tips include having a steady income, a down payment, and the security of knowing you will be living in the area for the next few years.
Many people are finding that banks aren’t offering as many loans as they were just a few years ago, and while that is true to a certain degree, most of the loans they are declining are the type they never should have offered a few years ago – including the so-called liars loans, sub-prime mortgages, and those that stretch borrower’s limits financially. If you have a good credit score, a low debt to income ratio, and are buying a home you can afford, you should be able to get a mortgage fairly easily.
Once you find a house you want to purchase, you will need to consider a few other factors, including how much of a down payment you can afford, the interest rate, and whether or not you want to get a 15 or 30 year mortgage. The down payment is an important factor because most lenders want you to have at least a 20% down payment, otherwise they may require you to purchase Private Mortgage Insurance (PMI) which insures them against buyers defaulting on the payments.
Should you buy Private Mortgage Insurance?
There are several important things to know about PMI:
It doesn’t protect you – it protects the lender. Lenders may try to sugar coat it, but PMI only exists for their benefit, not yours. If you default on your loan,
Private Mortgage Insurance is expensive – and it’s not tax deductible. The cost of PMI is usually about one-half of 1 percent of the loan, divided into monthly payments. For example, if you buy a $200,000 home and only make a 10% down payment, you would have a $180,000 loan. One half of 1% of that loan would be $900, which would be the annual cost of your PMI, or $75 per month. To top it off, you cannot deduct this expense on your taxes.
Lenders probably won’t tell you when you have paid down 20% of your loan. Lenders like collecting your PMI – it adds up to hundreds, or even thousands of dollars per year (and potentially millions across all of their loans). They are happy to continue collecting until you challenge them on it by paying off 20% of your loan or by getting an appraisal proving your equity is above 20%. If you don’t challenge the lender on your PMI, they are required by federal law to stop collecting once your equity reaches 20%. But that still gives them a couple months of additional PMI payments unless you notify them first.
You can avoid PMI. Many lenders won’t tell you up front that there are ways to avoid PMI. Some of them include special mortgages backed by the government, such as a VA loan, or other programs for first time home buyers. You can also avoid PMI buy purchasing a home with an 80-10-10 loan, which is a primary mortgage of 80% of the purchase price, a second mortgage at 10% of the purchase price, and a 10% down payment. The second mortgage typically has a higher interest rate, but that can often be less than the cost of PMI.
In the end, Private Mortgage Insurance can be avoidable in some cases, and it’s usually best to do so if you can. It will save you thousands of dollars over the course of your loan.