As real estate continues to achieve record prices and prove once again its value as a long term investment, there’s never been a more important time for buyers to make sure they have a healthy deposit.
The recent sequence of interest rate rises that have pushed mortgage rates to around 6% means buyers must manage their finances carefully to achieve their dream of owning a home.
Ideally you should have saved a 20% or more deposit. But, that’s not an easy achievement, and it’s accomplished by only 36% of America’s first time homebuyers.
There are several advantages to holding a large deposit before you enter the market. Arguably, the most important is the ability to avoid Private Mortgage Insurance often abbreviated to simply PMI.
It’s a policy your lender will insist you purchase if your deposit is less than 20% of the loan you’re seeking.
Designed to protect them if you default, the policy does nothing for you and can cost several hundred dollars each month. It also reduces the amount of money you can borrow because those payments are added to your outgoings.
PMI is a burden for more than 60% of America’s first time homebuyers, so this is how it works:
What is PMI?
It’s a monthly premium paid to an insurer who covers the balance of your mortgage and pays it to a lender if you default. It does not protect you in any way. If you default, the lender can (and probably will) foreclose.
You’ll lose your home, and your credit score will be shredded.
How to Avoid PMI
It is used for all standard mortgages where the 20% deposit threshold has not been met. The system works differently if the Federal Housing Administration backs your loan. No insurance is required for Veterans Association (VA) and agriculture dept (USDA) loans either, but they implement a funding fee.
Your Bottom Line
The cost of PMI depends on the size of your loan and your credit score. It’s best to discuss your situation with a qualified adviser. A report issued by Ginnie Mae suggests the fee ranges from 0.58% to 1.86% of the original loan amount. At the higher end, PMI monthly payments can be more than $300.
Any Good News?
PMI is tax deductible. Better still, you no longer pay the premium once the equity in your loan exceeds 20% of your loan’s value. So, reduce your loan quickly to stop paying the monthly fee.
Consider the consequences of entering the market with a deposit of less than 20%. But if you find an ideal property before you’ve reached that savings threshold, it might be a smart play to act immediately to avoid losing the opportunity.