Many borrowers in today’s home buying environment do not have 20% down. And this is OKAY! Needing a 20% down payment to purchase a house is a common misconception. For Veterans, Active Duty Personnel and some people buying houses in more rural areas you can get away with 0% down payment. For most others the minimum down payment is usually between 3% and 5%.
This is great news for many first time home buyers or even home buyers that are selling their current homes as it provides lots of added flexibility to the home buying experience.
This lead to a question from a client of mine recently:
“I have heard about lender paid PMI – where you don’t pay PMI but you pay a slightly higher interest rate on your home – what are your thoughts on this?”
Great question… let’s dig in.
When you put less than 20% down payment on a house you are required to have Mortgage Insurance on your home loan. This differs from Home Owner’s Insurance. If Home Owner’s Insurance protects you from a loss on your house think of Mortgage Insurance as protecting a loss on the lender that is loaning you the money to buy the house in regards to potential foreclosure or short sale, etc.
There are two main kinds of Mortgage Insurance (however, there are several other options that could made sense for you too; ask your Loan Officer):
- Monthly PMI (Private Mortgage Insurance)
- LPMI (Lender Paid Mortgage Insurance)
Both options have pros and cons and which one to go with depends on your specific situation. So it is always good to sit down with your Mortgage Loan Officer and discuss and weigh out each option.
Option 1, Monthly PMI is a good option if you plan on being in the home generally for 5 or more years. Eventually the Monthly PMI will be cancelled off your loan once you reach 78% loan to value (which is simply just taking your current mortgage balance and dividing it by the lesser of the appraised value or purchase price at the time you purchased your home). The pro to Monthly PMI is that eventually you will meet that 78% loan to value requirement for PMI cancellation and your monthly payment on your mortgage will drop by that Monthly PMI amount (many times this is going to be several hundred dollars a month). The other pro is that choosing the Monthly PMI option will give you access to the lowest interest rate you qualify for. The con for this option is that of the two options it is going to lead to the highest monthly mortgage payment.
Option 2, LPMI is a good option if you do not plan to be in the house as long, or perhaps you plan to say refinance down to a shorter term within the first few years of owning the home. Since this is called “Lender Paid” Mortgage Insurance what is happening here is that your Lender is going to pay the Mortgage Insurance on your behalf in return for a slightly higher interest rate. The change in interest rate can vary based on your specifics (down payment amount, credit scores, etc) but as a rule of thumb it usually works out to at least .25% higher in rate. The pro to LPMI is that in the short term you will have a lower monthly payment. The con for this option is that over time the slightly higher interest rate will mean you will pay more for this option over the long term in interest. So again this why I suggest this type of Mortgage Insurance option to folks that know they won’t be in the home very long (usually 3-5 years, but sometimes as much as 8-10 years). This option would be good fit for people that are constantly being moved for work, or that expect a pay raise in the near future and plan at that time to refinance into a lower term.
Hopefully this helps you understand that even though you don’t have a full 20% down payment set aside for your future home purchase that there are still options for you to purchase a home, and options that can make some real financial sense if you are given the opportunity to dig into them and weigh the pros and cons of your specific situation.
If you have further questions on this feel free to email me directly at firstname.lastname@example.org call or text me at 913-735-5363 leave a comment below or reach out to me via Facebook at www.facebook.com/bakerloans or hit me up on Twitter at @affinityloans.
-Michael B. at Affinity