I recent got an email from a reader of this blog, who asked this question:
My wife and I just found the perfect house, but there’s a problem. We weren’t really planning on moving for another few months, and our down payment fund isn’t as high as we’d like it to be. We know we can save enough money to get us to the 20% mark over the next few months, but we also realize that if we wait until that point to put down an offer, our dream house will almost certainly be gone. Are we crazy to think about taking out a loan with PMI?
-John (not his real name)
With John’s permission – provided I keep his real identity anonymous – I’m going to give my opinion on his situation, and put it to you for some added advice. While Lauren and I are nowhere near buying a house (especially in our area), I’ve started to gain an interest in the housing market.
Today’s housing market is ever-changing; in some places, the recovery is in full swing, in other locations, housing prices and sales are still lagging. We’ve seen record or near-record low interest rates for much of the past year, and although we’d like to believe that rates will stay low indefinitely (word from the Fed suggests they will stay low, likely through at least 2013), there’s always the chance they could start to climb once again. Housing prices, too, could start their ascent. In other words, we can’t expect it to remain a buyer’s market forever. There are some really incredible deals out there, John, and if you think you’ve found one that meets your wants and your needs – and are in the position to afford the monthly payments comfortably – I don’t think it’s out of the question to do that.
But I would add this caveat about PMI (private mortgage insurance). First, aim to have a down payment of at least 10% of the purchase price, so you lock in the lowest tier of mortgage insurance. Next, continue saving after you purchase the property, just like you would if you were still working feverishly to save up for that down payment. Put those extra payments toward the principal of your home loan. Once you reach 22% equity in your home (meaning you’ve paid down the mortgage to 78% of the purchase price), your lender is required under the Homeowner’s Protection Act to automatically cancel your PMI.
There’s a way to shed your PMI even earlier. Once you reach a loan-to-value (LTV) ratio of 80% or less, you can ask your lender to cancel your mortgage insurance. We’re talking LTV here, not a percentage of your loan or the sale price. You may be able to get an instant boost by having your house appraised soon after the purchase; this is a great idea if you’re buying a distressed property at a deep discount (the value is almost definitely going to be higher than what you paid for it). Even if you don’t have your home appraised for a better LTV ratio, making those extra payments until you reach the 20% equity level – then asking your lender to cancel PMI – will help you out immeasurably.
The way I see it, if you snag your dream home right now – and take on PMI in the process – but can put enough toward the principal over the next few months, you may be able to get rid of the mortgage insurance quickly. Say it takes you six months, during which time you’re paying $100 a month in PMI – that’s $600 to get your dream home. It’s not chump change, but if you’re on solid financial footing, it’s also not the end of the world.
Reader, what do you think? Do you think taking on PMI is a horrible idea altogether, or if John plans on paying down his principal – just like he would add to his down payment fund – that canceling the mortgage insurance a few months from now is a viable option?