Wait? Is that what you meant to say? That paying PMI is an…investment?
Almost every client we meet looking to get a home mortgage approaches Private Mortgage Insurance (PMI) as an evil expense and is willing to bend a home search and a home-buying plan around “avoiding PMI.” These clients are often already feeling pressure over wanting to have more money saved for a down payment, and now they are faced with an additional monthly cost. They are trying to squeeze pennies from every possible place to afford a new home and now they have to consider “throwing money away” on PMI? It sounds like an unwise choice.
I am chatting today with Rich Clayton, founder of OnTo Mortgage and the number one lender for our team for almost 20 years, about PMI and what the reliable data are for clients.
So Rich, What is PMI?
Rich: PMI is the abbreviation for Private Mortgage Insurance. People are usually introduced to PMI when they hope to get a mortgage to purchase a home but are planning to put down less than 20%. In that case, the primary lender wants to have insurance because the borrower is categorized as a higher risk, and, therefore, the borrower is required to pay for the insurance on behalf of the lender in order to obtain that mortgage.
At this point, the borrower usually pulls back and reacts negatively.
What kinds of reactions do you hear when you talk to people about PMI?
Rich: They respond with: “I don’t want to pay PMI. It is expensive, it means I can’t afford my house payment, my parents said to avoid it at all costs, my financial advisor says to stay away from it, and it’s a complete waste of money. I don’t want to pay more than someone putting down 20%.”
I am guessing that you are going to tell us that this isn’t the complete picture? I always tell clients that PMI is a tool and to call you.
Rich: So my goal at this point is educating them on exactly what the cost of the PMI is, for how long the PMI is necessary to have, and how to potentially get rid of PMI in a shorter term.
Sometimes my clients want to wait to buy so that they can save up enough to avoid PMI…what are your thoughts?
Rich: There are a few choices here for how to make a purchase without paying monthly PMI. Lender-paid mortgage insurance is an option that lets a buyer pay a slightly higher interest rate on the loan, and the lender pays the mortgage insurance up front. In that case, the buyer is paying a higher interest rate for the term of the mortgage. In the end, the buyer would likely end up paying more for the mortgage insurance than if they paid it as a monthly payment.
Another option is to piggyback a mortgage where there’s a first mortgage for 80% and a second mortgage for 10%. The second mortgage is usually a home equity line of credit and the interest rate on the first mortgage is a little higher and the second mortgage is interest only.
These are both tools that you can use to get into a home.
So how does PMI compare to these methods and is it really a financially savvy choice?
Rich: So I give them an example and look at their total payment. Let’s say on a $500k purchase with 10% down, the PMI is $100 per month.
What does that look like for 2 years? That total cost is $2400. And that cost is lower than going their lender-paid route or the “2 mortgage” route.
Well, let’s put that aside for a second and assume they didn’t buy and get a new mortgage, they didn’t own their own home, but they were paying rent, which is money out the window too.
However, let’s not compare “rent vs buy” for this, but just look at PMI, and assume property values go up 4% a year.
We know right now in the greater Boston area, things have been going 5, 10, maybe 15, 20% or even higher, but very, very conservatively speaking, let’s say the property values on average, are going to go up 4% per year. 4% on 500,000 is $20,000. Times 2 years – that’s $40,000.
So had the potential buyer purchased the property two years prior and paid the PMI, they would not have taken advantage of the additional increase in value through appreciation, or that $40,000.
Now, let’s compare the cost versus the potential gain. So your cost, as we talked about was $2,400 over that two year period and the potential gain that they would have given up had they not purchased would have been the $40,000 in equity.
I always like to compare this to an investment. If you were working with your financial planner and he or she said, “Give me $2,400 today. And in 24 months, I’m going to turn your $2,400 into $40,000.” Would you make that investment?
Of course you would make that investment. It’s 15 times your money over a 24 month period. There’s no other investment today that you could make that would even get close to that. So there’s an example why using PMI could be advantageous in a rising rate environment, because we know rates are going to go up and property values over time are always going to go up and you could use that as a tool to maximize your wealth potential or maximize your return on that investment.
And we could get into all the other reasons why you’d want to buy. The additional principal that you’re paying down every month…that’s like for putting money into savings, not to mention the deductions you put on your tax return.
So the point here is PMI is a good thing?
Rich: It allows you to buy without having to put down 20%; where you can leverage the bank’s money instead of utilizing all of your money. You don’t have to put down 20% and tie up all your money, but you are able to put down less money.
Hope that answers any questions you might have. Feel free to have your buyers reach out if they would like to talk about this in more detail.
Thanks, Rich! Always good to get sound advice.
We just want to reiterate that there is no one right answer for what is the “best loan” for every buyer, for every property, in every situation. It always pays to work with a lender like Rich Clayton at Onto Mortgage to look carefully at your needs and goals and to develop a loan strategy that moves you forward.