As I mentioned sometime ago, in my article Mortgage 101, the typical limit for a well written new mortgage is 80% of the house’s appraised value, or 80% LTV (loan to value.)
But, what if you come up short, and instead of having a full 20% down, you only have 15%. This is when PMI comes into play. PMI, the initials for private mortgage insurance is the fee you’ll pay each month until your loan is down to the 80% of the initial home value. What I want to look at today is the cost of PMI, with a focus on those loans that are at that 15% down range I suggested.
The FHA has recently announced the PMI rates effective June, 2012. The rate is 1.2% for a loan up to $625,000.
Let’s work out the math here. You wish to buy a home that’s at the median $140K or so. You put down 15% or $21K, and the loan value is $119K. The dollar amount you are short from being at the full 20% down is just $7000, but you will pay 1.2% per year on the $119K mortgage, or $1428 per year until the balance is paid down to $112K. On a 4%, 30 year loan, this will take about 3 years, not too bad, but look at the numbers, an annual cost of $1428 because you needed an extra $7000. Let me do the math for you, this is 20.4%. In addition to the interest on the mortgage.
On the other hand, if you only put 5% down, the PMI rate rises to 1.25%. On that same $140K house, your loan is $133K, and your PMI, $1662.50 per year. But, when you consider that you’re paying $1662.50 for the fact that you are short $21,000, it’s more like a 7.9% adder for that missing $21K. Not a great deal, but a far cry from 20%+.
What do I conclude from these numbers? First, I maintain that 20% down is the right thing to do, but if you are close to having the 20%, avoid the 85% LTV, and raise that extra cash however you can. If a small 401(k) loan can help you avoid PMI, do it. If you need to borrow from friends or family, put a plan together, offer them a decent rate, and take that side loan.
Have you ever taken a mortgage that came with the need for PMI? Did you understand how much it was going to cost you?