|Avoiding a PMI with less than 20 percent down
Buying a primary home? The 20 percent down rule is yesterday’s news. More down payment options exist, including both government and private sector alternatives, allowing more flexible choices.
Don’t be fooled however, as most of the programs that allow for less than 20 percent down include PMI, an added premium built into the mortgage payment. If you don’t have 20 percent down to buy a home, and you want to avoid PMI, pay close attention.
Quick PMI cheat sheet
PMI, otherwise known as private mortgage insurance, is a percentage of the loan amount added to the house payment. On common FHA Mortgage types, 135 basis points of the loan amount on an annualized basis is the premium. For example, a loan amount of $400,000 is $450 per month in PMI (excluding principal and interest, insurance or property taxes).
Looking at conventional mortgages, PMI can range from anywhere from 30 to 120 basis points. More commonly, expect an average PMI to be approximately 50 basis points of the loan amount. Using our 50 basis points example on a loan of $400,000, that’s $166 per month in PMI.
80/10/10 is back
Popularized in the lending heyday from 2004 2007, the program allows for a buyer to put down just 10 percent of the purchase price of the home. In most cases, a 10 percent down payment would require monthly PMI. Using the 80/10/10 approach, your lender would provide 80 percent first mortgage, that same lender and/or a subsequent lender would provide a 10 percent second mortgage in lieu of the monthly PMI, while you contribute the 10 percent down payment, sealing the deal.
• Key tips: Most lenders will allow for secondary financing up to 90 percent combined loan-to-value (combined loan-to-value meaning first and second mortgage combined loans) up to the maximum county conforming loan limit in which the property is located. While the majority of mortgage lenders typically do not offer second mortgages, smaller pocket-size lenders are entering the marketplace aggressively with the 80/10/10 solution. Plan on having at least a 700 credit score and 10 percent down of your own funds.
Some lenders may even still allow 10 percent to be gift funds, so check with a qualified mortgage professional.
Alternatively, rather than electing the monthly payment option, a buyer with as little as 5 percent down can choose to prepay the mortgage insurance up front in a one-time premium called single-pay mortgage insurance. Not all lenders offer it, so buyers would be best served doing their comparative shopping.
The program works by simply pre-paying a chunk of the future PMI payments up front as a fee at the closing table. This can be anywhere from 1.75 to 3 percent of the loan amount.
• Key tips: Like the 80 10/10 program, a 700 credit score would be required, and the single-pay mortgage insurance amount can be gifted.
Gift of equity
Do you live in a family owned property? May you have the ability to purchase the property you rent from your landlord? In either instance, the owner of the property, whether that be a personal family member or a landlord, for example, can provide a gift of equity for at least 5 percent of the purchase price as well as for closing costs and single-pay mortgage insurance. A gift of equity is simply the seller of the property providing funds for the benefit of the buyer and accepting less net proceeds at closing.
• Key tips: Lenders are going to require a letter of motivation on why the family member or the landlord is selling their property to a buyer with whom they have a personal relationship. There could be a variety of reasons, so it’s crucial to make sure the structure is properly reviewed by a qualified mortgage professional. This letter of motivation will address what’s called a non-arm’s length transaction occurring when there is a relationship between the buyer and seller. The lender places more scrutiny on transactions with this in place because of potential fraud for profit schemes.
Deal sweetens for
Have previous military experience with a general or honorable discharge? The Department of Veterans Affairs allows eligible veterans with a certificate of eligibility from the VA (shows their loan eligibility) to purchase a home with no money down as well as no monthly PMI, with loan sizes even as high as $1,050,000 in some high-cost areas. Sonoma County, for example, has a max loan limit at $520,095.
• Key tips: Eligible veterans will typically pay a 2.15 percent guarantee fee of the loan amount from the Department of Veterans Affairs, which is added to the loan amount and then re-amortized over the term of the loan. For example on a loan of $500,000, that’s $10,750 added to the loan amount, making the financed loan amount $510,750, still most attractive compared to a PMI premium on another program.
If you plan to buy a house in the near future, these possibilities represent a tangible alternative to simply putting down funds and taking PMI on a monthly basis. While you might elect to do that anyway, PMI depending on the loan program, may be removed in the future. Check with your lender on PMI removal as the specific characteristics tied to your initial down payment, and mortgage loan program may differ.
Scott Sheldon is a local mortgage lender, with over six years of experience helping people purchase and refinance primary residences, second homes and investment properties. Visit him at www.sonomacountymortgages.com.