As with any large purchase, we have to do a little investigating and put in some thought before making a decision. One of the primary things to consider in deciding if you’re honestly ready to buy a home: Do I have sufficient down payment? To avoid paying for PMI (private mortgage insurance), lenders require 20% down. For a $400,000 home, that is $80,000. Of course, lenders will need some amount of money upfront; the higher the amount the lower the mortgage insurance.
It’s worthy of noting that PMI protects the lender and not the mortgage holder. If you fail to make your payments, you could still have your home foreclosed. The PMI that you pay covers the lender’s losses only.
There are many situations where paying PMI helps the borrower, among them:
- When home values are going up, and are expected to keep going up. This way, a borrower can join a promising market in the absence of a 20% down payment. Hopefully, the cost would be offset by the gain in value over time.
- When mortgage rates are expected to rise. You’ve likely seen in other Crown Mortgage of the West Insights how much is added with each ½ a percentage point in your interest rate. The PMI (which can add between 0.3% and 1.15% on your loan) but can be offset by the savings in avoiding a higher rate.
- When you want to use the money for other purposes. In some situations, it may make more financial sense to pay off higher-interest debts instead, or to invest the money for potentially higher returns. BUT, many borrowers choose to put a smaller down payment and use the other money to pay off an auto loan or a credit card. To me, that’s a HUGE mistake, especially in the case of the auto loan, because you are now financing your depreciating automobile for 30 YEARS!!!
If it’s your desire to use less than 20% down to buy in an area that is increasing in value or will have a chunk of cash with which to pay down the mortgage, paying PMI allows you to get in now and reap the advantages of housing market appreciation. AND, if you use the monthly or annual MI option instead of the one-time lump sum or interest rate adjustment, there is a good chance that you can have the MI removed from the loan (except in the case of FHA) once your equity becomes sufficient.
Compare the costs of homeownership (monthly mortgage, insurance, property taxes, maintenance costs) versus your current outlay for a rental. You might also factor in the financial impact that will result from your commute, parking, tolls, room/basement rental, as well as access to public transportation, parks, or other places you frequent.
And beware, often a lender says that you can afford a higher monthly mortgage than reality dictates. Be careful, I believe that a good rule of thumb for determining an affordable monthly payment, taxes and insurance total no more than 45% of your Gross Scheduled Income.