When I first graduated from college, my plan was to rent for one year and then purchase my own home. When I look back at my financial situation at the time, I didn’t fall into the perfect financial scenario of home ownership: I didn’t have a 20% down payment saved that would have helped me avoid having to pay Private Mortgage Insurance (PMI), and I was still establishing a credit history, so my credit score wasn’t very high. I still purchased the home.
I’ve found that there are many others in that same boat. For various reasons, they don’t have 20% saved and/or their credit score isn’t what they would consider stellar, but they aren’t interested in renting for very long and still want to achieve their dream of home ownership sooner than later.
This is where PMI often comes in to play. PMI is there to protect the lender in case you default on your mortgage — what it means to you is that your mortgage payment will basically be higher than it would be without PMI. Having a higher credit score, and at least some form of a down payment (like 10% down) could make your PMI less expensive.
Should you wait to buy a home until you can avoid PMI? Some people prefer to do so, but others go ahead and buy the home. Here are the pros and cons.
Pros of PMI
1) Allows you to buy without using up all your savings. We all start off in different financial places. You may not have an inheritance, a large salary, a parent or family member to get a down payment from, or you may just not have the flexibility in your budget to save 20% of a home’s purchase price without compromising other savings needs, etc. It could take some people years to build enough to put 20% down on a home and in the meantime, that person might have to rent when they prefer not to. PMI can help you get there sooner.
2) Opportunity to build wealth sooner. Real estate values can fluctuate, but long-term, odds are that you will see the value of the home you purchase increase over the years. Eventually you may be able to tap into that equity by selling or obtaining a line of credit to accomplish another goal, etc.
3) You still keep control of your budget. There’s a tradeoff. Some people look at PMI as simply a cost to build wealth. If this is you, you might look at it as just another line item on your budget sheet. Make sure you factor PMI when determining whether your total mortgage payment fits within your housing budget.
4) You may be able to deduct the cost on your taxes. Congress still allows mortgage insurance premiums to be deductible as mortgage interest on your taxes. Be sure to stay abreast if tax laws eliminate or reduce your ability to claim this deduction, but for now, this falls in the ‘pro’ bucket.
Cons of PMI
1) Forego opportunity to save/invest that money instead. Let’s say your PMI is an extra $100 per month — you could take that extra payment and invest it instead over the long-term, which would help you to accumulate quite a bit in savings. This is very true, but is that what you would do with the extra hundred bucks?
2) Increases your monthly payment. To offset the cost of PMI, you could decrease spending in another area. You might spend less on a depreciating asset like a car, or cut back on how much you spend eating out or on your cable bill.
3) PMI can last for many years to come. PMI will be there until you reach 78 – 80% of the loan-to-value of your home (20% equity), or refinance (if the cost to do so isn’t higher than the cost to keep PMI) depending on the terms of your loan. As you make payments while the value of your home increases, you may find yourself getting closer to having that 20% equity sooner than you thought you would.
Keep in mind that the 20% equity is based on the home’s original appraised value when it comes to determining whether you have reached that 78 – 80% mark, so in order to take advantage of any increase in value since you purchased, you’d have to refinance to rid yourself of PMI sooner.
Also, as your financial situation gets more flexible, you might be in a position to add extra payments or a lump sum to your mortgage to help you get rid of PMI.
The bottom line
If you can save enough to get 20% down, that will save you on your monthly payment and you can put the money you would have spent on PMI towards another goal.
But if home ownership is important to you right now, and being in a position to avoid PMI doesn’t work for your situation, don’t be discouraged. Consider your budget and the pros and cons, so you can make an informed decision. It was worth it to me.
Check to see if you qualify for a First Time Home Buyer Down Payment Assistance Program that offers financial support that can be used towards the down payment and closing costs. Some plans count those funds towards that 20% requirement. You may also want to look into other programs, like NACA, which don’t require a down payment, closing costs or PMI in order to purchase a home.