Mr. Misunderstood: Mortgage Insurance
For many families, the thought of saving up a 20% down payment in order to purchase a home can be daunting. Record high home prices already make some believe owning their own home may be out of reach.
In Knoxville, TN, according to realtor.com at the time of this article, the median list price is $400,000. In the greater Nashville metro, the median list price is $550,000. It should come as no surprise that the idea of saving up $80,000 to $110,00 for the purchase of a home just feels impossible.
Enter an unlikely hero, from years of being labeled as a villain: mortgage insurance.
Mortgage insurance might just be one of the most misunderstood and misrepresented tools in the homebuying universe. Historically, mortgage insurance was considered something to be avoided at all costs, as it can be a costly addition to your monthly payment with seemingly no benefit. We disagree.
First, let’s talk about what mortgage insurance really is.
Mortgage insurance is basically an insurance tool that protects the lender in the event the buyer of a home fails to pay their mortgage, and the bank can’t sell the home for enough money to pay the loan off. It’s often confused with homeowners insurance, otherwise known as “hazard insurance” which protects the owner of the home in the event of a catastrophic loss like a house fire.
Mortgage insurance comes in many forms ranging from “MIP”, which is used to insure some government loans to “PMI” or private mortgage insurance, which is used to insure conventional loans. Some lenders will even offer a “no PMI” option where they essentially self insure through offering the borrower a higher rate to offset the risk.
The bottom line is that if you put less than 20% down, a lender wants to protect themselves somehow, and will find a way to pass that cost along to the borrower. Don’t be fooled by claims otherwise – in the world of economics, there is no such thing as a free lunch.
Today we are talking about PMI and how it relates to conventional loans. One perk of PMI paired with a conventional loan over its government competitors is that it automatically falls off once the loan balance reaches 78% of the purchase price. You can also petition the lender that holds your mortgage to remove PMI in the case that your value has increased and/or your mortgage balance has been paid down. Most lenders have a process for this, and at the end of the day it’s their choice, but if you meet their guidelines they will oblige with some persistence.
So, how is this some unsung hero??
Mortgage insurance made homeownership possible for those who wouldn’t have been able to buy a home otherwise, and now, it might just be a way for you to make a more financially secure decision buying a home.
Here are five ways mortgage insurance might be a tool to help you make a great home buying decision in 2022:
- Buying a home with a fixed rate mortgage, even with less than 20% down, secures your housing payment at a time when families right here in Knoxville are being priced out of their homes. Your landlord can raise your rent, making it unaffordable for you to stay where you are, but if you own the home and have a fixed rate mortgage, your principal and interest will hold steady, no matter the housing environment.
- Even if you have the funds for a 20% down payment, you might be able to put as little as 3-5% down and use those funds to pay off other higher interest debt, and lower your overall monthly expenses more so than if you had just put that money down on the purchase of your home.
- Likewise, if you have to spend your entire savings on a 20% down payment, it might be wise to consider putting 10% down instead, and leave the other 10% in the bank for a rainy day. It is often said that “cash is king”, and when you fall on hard times financially, having adequate savings to keep your family afloat is a key to remaining financially independent. A quick rate quote through one mortgage insurance vendor shows that a first time home buyer with a 760 credit score purchasing a $400,000 home in Knoxville could put 10% down and pay just $54/month* in mortgage insurance. Is keeping $40,000 in additional down payment in a rainy day fund worth $54/month plus some additional principal and interest to you? For a lot of families, that is the case.
- It can be used to bridge an appraisal gap. Meaning, if the sales price is $400,000 and the appraisal comes back at $380,000 and the seller is unwilling to negotiate the sales price, you might be able to bridge the gap with mortgage insurance. If you were putting 20% down originally, your loan amount would be $320,000. Instead of having to bring an additional $20,000 to closing, the same family referenced in number three could pay just $32* more per month and keep the money needed at closing the same.
- It gets you in the game. For a conventional loan, mortgage insurance makes it possible for some buyers to put as little as 3-5% down on the purchase of a home. When we bought our first house in 2016, we put 5% down and it was just about all we had. Fast forward 6 years and our home value has grown and our payment has stayed the same. We were even able to petition our mortgage company to release us from mortgage insurance due to the increase in value from appreciation and work we did on the home.
The bottom line.
With increased competition in the mortgage insurance space, private mortgage insurance has become more and more affordable, and now needs to be considered a tool to improve your total financial picture, outside of just your monthly housing payment.
For all the reasons listed above, we need to rethink the way we view mortgage insurance and approach each home purchase on a case by case basis. Securing your housing payment, channeling funds towards higher interest debt, keeping more money for a rainy day, bridging appraisal gaps, and being able to participate in one of the greatest wealth building engines available to everyone can be worth the cost.
*quotes run from Arch MI’s Ratestar online tool