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Down Payments: 10% is the New 20%

Most people have heard that if you have a 20% down payment, you don’t have mortgage insurance (or as most people know it, PMI).

But, who has that kind of money lying around? And is it worth it to buy a house if you have to pay this insurance? Even though government regulators and legislators have been coming down hard on lenders, they have been marching forward, improving the requirements, and making sure people can still buy houses.

Down payments and mortgage insurance are closely related, so before we talk about down payment options, let’s back up a little and address a few questions about mortgage insurance…

What is mortgage insurance (or PMI)?

Mortgage insurance is basically an insurance policy that lenders take out just in case you stop paying your bills. Look at this from the Lender’s point of view for a moment: The more of your own money that you use for a down payment, the more “vested” you are in the house. Right before the housing market crashed, there were “No Down Payment” loans.

If you walk out of the house, it doesn’t cost you a dime. But, if you put money down, you are going to reconsider walking out. Statistically, once you have at least 20% vested in the house, you’re less likely to walk away, and you’re a much smaller risk to the lenders. So, 20% down, no mortgage insurance. The difference between this and other insurance is that YOU pay the premiums—not the lender.

What does PMI stand for?

First off, “mortgage insurance” is the generic term. And, PMI is a more specific kind of mortgage insurance. It stands for Private Mortgage Insurance because there are lots of insurance companies that offer it—just like health insurance and car insurance. The word “private” refers to the fact that they are private companies—not government.

So that means there is government insurance, too. The most common government mortgage insurance is through FHA loans. To make sure it’s confusing enough, they call it MIP, or Mortgage Insurance Premiums. But for simplicity, whenever you see PMI, MI, LMI, UFMIP, LDPMI, LPMI, etc… just know they mean some sort of mortgage insurance.

How do I pay them?

There are a number of ways to pay mortgage insurance, and depending on your loan, you may have a combination of mortgage insurance.

  1. The most common is monthly. Usually, it’s calculated as a percentage of the loan amount.

  2. You can pay it all up front. Thousands of dollars. This is called Up Front Mortgage Insurance Premiums (UFMIP). Since it’s up front, it’s a smaller amount than if you stretch it out and pay monthly.

  3. You can increase your interest rate. From the lender’s point of view: More risk, More reward. Giving you a loan with a low down payment is the risk, to the reward is more return on interest. I’ve seen rates jump as much as 4.5% to 5.5%, and I’ve seen as little as 4.0 to 4.125%. Depends on the lender, the down payment, your credit, and so on.

For instance, if you get an FHA loan, you will pay mortgage insurance up front (UFMIP), and you will pay a monthly premium (MIP). You pay a lot of insurance, but the benefit to you is that you can buy a house with as little as 3.5% down.

After the housing crash, this was the lowest down payment option (unless you’re a veteran). However, in today’s market, there are much better options.

How long do I pay mortgage insurance?

This all depends on the lender and the type of mortgage insurance (or MI) you have. Before we talk about the length of MI, let’s discuss the concept of loan-to-value (or LTV). If you buy a house for $100,000, and have a 20% down payment, your loan would be $80,000 which is 80% LTV. Most loans over 80% LTV have some sort of mortgage insurance. If you pay a monthly premium every month, it usually that drops off once your loan goes below 78% LTV.

However, if you come into a large sum of money and pay down the balance to get below the MI threshold, there are a few limitations. For instance, some lenders make you wait at least two years before you can remove it. In other cases, let’s say you buy a fixer-upper for a low price. You fix the home, and now it’s worth more.

Your loan amount compared to the new increased value might get you below the 80% or 78% threshold. You still might need to wait two years, but you will also need an appraisal (or BPO –Broker’s Price Opinion) to verify the value. However, if you have a special kind of MI or a higher interest rate in lieu of MI, it may be on there for good and they never go away. Depending on how good interest rates are, you might want to consider refinancing.

Back to Down Payments

Let’s not kid ourselves… Real Estate in L.A. is expensive. For that reason, lots of first time homebuyers get help from their families with down payments, but not everyone. Aside from those lucky beneficiaries, if you’re buying a middle-of-the-road house for $500,000, that means saving up $100,000 for a 20% down payment might take you years. And worse, if you only have enough for 5%-10% for a down payment, most standard mortgage insurance programs will bankrupt you!

Here’s the good news: Some lenders in L.A. simply add 1/8% to your interest rate if you can put 10% down. That means that if you have a $500,000 loan, your mortgage insurance only costs you $52 extra a month. Compared to the whole mortgage payment of around $2,400, an extra $50 is almost nothing! And just to clarify, you can use this same 10% program for a house worth $1.4 million.

Quick Disclaimer: There are some "smoke and mirrors" tactics these lenders use. In addition to the 1/8% bump in rate, they will also calculate the rate based on 10% down versus 20% which will raise the rate significantly.

Another quick disclaimer: Obviously, if you’re putting 10% down versus 20%, your payment will be larger to account for the larger loan amount. But, if you were currently putting money away for a down payment anyway, the payment should be well within your budget.

There is also a new program through Fannie Mae offering a 3% down payment. Currently, the only other option is an FHA loan which offers a 3.5% down payment. This is similar, but the difference is in the MI. Like I mentioned earlier, FHA has a monthly premium as well as an up-front premium.

This makes the Fannie Mae program much more affordable because which means you can buy more house and have the same monthly payment. Not to mention, in some situations, it can be tricky getting approved for a condo with an FHA loan. Yes, financial regulators are making the approval process more difficult. And even then, the good mortgage guys can make things happen. But, even with the tough requirements, at least the lenders are becoming more flexible with the most important part: Down Payments & Affordable Mortgage Insurance.

How does YOUR lender measure up to MY lender?

Last Thought: These concepts get very technical very fast, so with that said, all you really need to know is there are options out there, and people like me can help you.

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