A big question that many real estate professionals are asked about simply comes down to PMI. If you’re a first time homebuyer with a low down payment, you will become quickly familiar with the term ‘PMI’. Most lenders require PMI when a homebuyer makes a down payment of less than 20% of the home’s purchase price – or, in mortgage-speak, the mortgage’s loan to value (LTV) ratio is in excess of 80% (the higher the LTV ratio, the higher the risk profile of the mortgage). When it comes to PMI, which means Private Mortgage Insurance, your payment has an added fee to cover the risk of having a low investment (down payment) on the property.
According to Forbes.com, “A conventional loan is a traditional mortgage from a lender that is not insured by a government agency. With a 5 percent down payment, the borrower finances the remaining 95 percent over 30 years with a 4 percent interest rate. Private mortgage insurance (PMI) is required because of the low down payment and is $78 of the monthly bill, making the total monthly mortgage payment $1,143.”
The above is a great example of how PMI works, but is it a bad thing? The good news is that PMI allows people to get into a home quicker and with less money. A borrower can get a conventional loan with PMI with as little as 3 percent down. PMI can be cancelled once 20 percent equity in the home value is reached, which means your monthly bill decreases. Less money on both sides of this deal is a great thing. For many prospective homebuyers looking to lock in low interest rates, build equity and home appreciation faster, an option to get into a home with the lower down payment may be a better option than waiting to come into 20% of cash to put down the down payment on a home. It is just a matter of the culture we live in.
If you can get away with no PMI, that’s great, but for most people – PMI is a reality and it is a small price to pay to start building equity.