Episode Transcript
[00:00:00] Speaker A: If you've ever thought about buying a home, it's likely you've heard it's always worth trying to put 20% down on a property to avoid private mortgage insurance. But in this episode, we cover whether it truly always makes sense or if there are times when you should pay as little as possible and choose to pay PMI. Let's get started.
[00:00:18] Speaker B: Let's get some money from new money new problems. It's the new Money New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.
Negotiating compensation, purchasing your first investment property. Helping your family with money. The highs and lows of entrepreneurship. New money brings new problems that require new solutions. Join us as we work through them together.
I'm Brenton Harrison, and this is the new Money New Problems podcast.
[00:00:56] Speaker A: Hello. My name is Brenton Harrison of New Money New problems, and your host for the New Money New Problems podcast. I hope you enjoyed last week's episode where I talked, talked about some of the things that, on the surface, don't make sense that we've decided to do as a family financially, but hopefully with more context. You came towards my side of the fence by the end of the episode. And as a part of that episode, one of the things that I talked about, uh, was the decision that we made before we purchased the home that we currently live in to actually go forward with paying PMI, or private mortgage insurance on our home loan when we actually didn't have to. So we touched on private mortgage insurance briefly in last week's episode. But in this episode, I want to go into further detail about what PMI is, how it's calculated, and give you even more context to a statement I made last week where there are periods in your life where, depending on what else you have going on financially, it's actually worth paying PMI. So, first, let's start with what PMI is in the first place. PMI, as I said, stands for private mortgage insurance. And at its core, it is insurance that's placed onto your home loan to protect your lender in the event that you default on your home. It is something that, uh, represents the level of risk that you are to the borrower, that at some point in time, you would walk away from that home loan, be it that you willingly walked away or you just simply didn't have the income to service the debt. So to take care of that risk, they add an extra premium to your home loan in the form of PMI. If you have a government backed mortgage like an FHA loan, instead of paying PMI, you might pay something like MIP or mortgage insurance premium. And while they have slight differences, the premise is the same. That when you have these type of loans and you don't put a large enough down payment down on the property, they put that extra premium on it to cover their back in the event of default. Now, after the break, we'll get a little more into the amount of equity that's needed into a property in terms of how you remove PMI. But suffice to say, kind of like the line in the sand, the gold standard that you typically hear of is 20%, meaning that if you want to avoid PMI on the front end of your loan, you have to do at least a 20% down payment. But you can also have, even if you didn't do that level of down payment, your PMI removed from your home loan, once you have paid it down to the point where you have at least 20% equity in your property, that's the line in the sand for borrower paid mortgage insurance. The second type of PMI that you can have on a property is something that's actually paid by your lender. And that is just like the name lender paid mortgage insurance. Lender paid mortgage insurance typically means that the lender will pay it for you, but they do so in exchange for charging you a higher interest rate on the home loan. And because they're charging that higher interest rate, the lender paid mortgage insurance never goes away. There are multiple ways to cancel borrower paid mortgage insurance, but you cannot cancel lender paid mortgage insurance. It's there for the life of the loan unless you decide to, at some point in time, refinance that property with another lender. Now, one caveat to that is with lender paid mortgage insurance, you have the option of paying for this mortgage insurance yourself upfront at closing. But the premise of this episode is, should you even make that big of a down payment? Are there sometimes when it makes sense to pay PMI? So it's not much of a, uh, benefit to say, oh, well, I'm trying to avoid paying as much on the front end, but I'm going to do so in this case, just so I can avoid PMI. But technically, it's an option with lender paid mortgage insurance. And you're probably listening to this and you're wondering, how much does PMI cost? Well, there are several factors that go into that, and we discussed it briefly in last week's episode. But PMI and the amount that you pay could be based on factors such as your debt to income ratio. It could be based on, uh, the amount that you put on the down payment on the property. But an element of PMI pricing that is often overlooked is the impact that your credit has on the amount you pay towards PMI. And if you're looking on screen at the same article we shared last week from Nerdwallet, it will give you some insights into how credit impacts those numbers. For example, if you have a credit score between 620 and 639, you might pay an average of 1.5% of the home loan on your PMI payments each year. Whereas if you have 760 and above as your credit score, you might pay an average of 0.46%. And that makes a significant difference. As a matter of fact, if we go to the top of this screen, we're gonna use an example where we have someone who has a home that's worth $400,000, and we're going to assume that they put a 10% payment down on that property of $40,000. This will be something that we touch on again after the break. So $40,000 10% down payment is clearly not enough to meet the 20% requirement to not have PMI on this home loan. And if we assume that this person has an interest rate of 7% and a credit score of 760 or above on a 30 year loan with this excellent credit score, they would pay on average, 0.46 of the loan towards PMI. That would be a monthly payment of $138 that they would pay for 8.35 years. And in total, they would pay $13,826 in PMI payments. Now, let's take that same example, but we're going to assume that this person has a lower credit score. Let's put their credit score between 680 and 699. And because that would likely impact their mortgage rate as well, we're going to assume that this person is paying 7.5% on the same home. Now, instead of 0.46, it takes their PMI payment up to 0.98, which goes from about $130 a month to $294 a month. And instead of paying a little over $13,000 over the course of 8.84 years, this cost them $31,000 in extra PMI payments. So the difference between the two is significant, and it has to be considered when we're building our case in the second half of this episode about whether or not it's something you should pay. Now that we've covered it, let's assume that you have it on your home loan, we can now discuss how you have it removed from your home loan, and there are several ways that you can do so. The first is you can notify your mortgage lender when you have paid your mortgage down to 80% of what the home was worth on the day that you closed. And there's a reason I'm using that distinct phraseology, because if you're depending on your lender to remove the PMI, they are not going to keep up with whether or not your property has increased in value from the date of closing. They're going off of what it was worth the day that you closed on the property. So, for example, if you have a home that was worth $500,000 on the day that you purchased it, 80% of 500,000 is $400,000. But maybe you don't put down the full 20% down payment. What you can do is you can continue paying on that loan. And once the loan balance is $400,000 or below, you can contact your lender, alert them to the fact you've paid down the mortgage to 80% of the closing price, and they will remove the PMI from your home loan. And unfortunately, you have to request this in writing or via email or over the phone once you've reached that 80%, because they will not automatically take the PMI off once you've reached 80%, even though it is your right to have it removed. However, the second way that you can have your PMI removed is you can wait until you've paid that mortgage balance down to 78% of the closing price. So in the example we discussed, if $500,000 was the closing price, $400,000 represented 80% of that closing price. But 390,000 represents 78% of the closing price. So if our borrower in this example did not alert their lender once they had reached 400,000, once they paid the balance down to 390,000, that lender would be required to remove PMI from the home loan. The third way that you can have PMI removed from your loan is you can get halfway through the repayment period. And this is something that's a protection for borrowers who maybe put a very small down payment on a property or a combination of having a small down payment and a high interest on the mortgage that they're paying. You see, we talked about in the past on this podcast the amortization schedules that lenders use when you have a loan, essentially saying how they calculate the exact amount that you need to pay to pay off the loan. In full throughout that repayment period. And we also discussed at the beginning of that loan period, almost every dollar that you pay is going towards just interest and very little is going to pay down the principal. It can take a very long time to repay small amounts at the beginning of a repayment period. Well, as a protection against how long it can take you to make a real dent in that loan. In addition to having the requirement that lenders remove PMI automatically at 78%, in the event that someone gets halfway through the repayment period and somehow still hasn't paid down their loan to 78% of what the original value was, they still have to remove that PMI. And then lastly, even before you have paid your mortgage balance down to 78% or even 80%, if you happen to live in a property that's increased significantly in value, you can request an appraisal from your lender. And while they're not required to remove PMI, there are several out there who, if your home is appreciated in value to the point where you are already well within the loan to value requirements to remove PMI, they will do so. So while there are several ways to have PMI removed from your property, we still haven't proven the point that there are some times, in my opinion, where it's worth paying in the first place. So after the break, we'll give you those reasons and we'll bring this thing on home.
[00:10:32] Speaker C: This is the new Money New Problems podcast, a show for successful professionals searching for the tools they need need to navigate financial opportunities and obstacles they've never seen. We'll be right back.
[00:10:51] Speaker B: Are you wondering what new money problems you might be overlooking in your financial life? If so, we've got great news.
We've crafted the new money new problems gap finder to identify potential weaknesses in your finances in areas ranging from budgeting, investments, insurance, and even the threat your extended family's finances could pose to your household. Please head to newmoneynewproblems.com gapfinder to complete it today. Again, uh, that's newmoneynewproblems.com gapfinder to take the assessment.
[00:11:30] Speaker C: You'Re listening to the new Money New Problems podcast. Subscribe now at new Money newproblems.com. welcome back.
[00:11:40] Speaker A: All right, welcome back from the break. It's now time, uh, for me to take on the burden of proof of showing you that there are some instances, not all instances, where you should pay less on your property, keep money in your pocket, and voluntarily pay private mortgage insurance. So I've got my notes here I'm going to start to build my argument for some of these circumstances. The first circumstance where you should not be worried about putting the largest down payment possible is if you have what's called a non conforming loan. Now, we talked about conforming loans before the break. A conforming loan is a loan that meets the guidelines of programs like Fannie Mae and Freddie Mac. Fannie Mae and Freddie Mac are two entities that buy a lot of loans that exist in the marketplace. So you might take out a loan with one lender, but a certain point in time, your loan might be sold to Fannie Mae or Freddie Mac. And to have a conforming loan, it means that you have to meet all of the credit requirements, the debt to income requirements, all of the things in the test that your lender runs you through. To have a conforming loan not only means that you meet all those metrics, it means that the value of your property is within those conforming loan limits. Anything above a conforming loan limit in terms of the amount you're borrowing is considered a jumbo loan. And the amount of a jumbo loan is going to vary based on the area in which you live. And the interesting thing about non conforming loans is they can have their own guidelines. So you could have different requirements in terms of your credit score, different requirements in terms of your down payment, and important to this episode, different requirements in terms of whether or not you have PMI added to your balance. And there are non conforming loans that are under those jumbo loan limits. So, for example, a VA home loan is a non conforming loan because it has its own requirements. But you can have a VA loan that's well within those jumbo loan requirements. But the interesting thing about once you cross over into a jumbo loan is there's a couple things at play. The first thing is it's highly likely that these loans will not be sold, right? It's a higher risk to the bank, it's a higher risk to the lender. So it's less likely that they can go find someone else to buy that loan, and they typically keep it in house. So if you get a jumbo loan through your local bank, it's highly likely that they're going to keep that loan for the entirety of the repayment period. But what's also highly likely is that to qualify for that jumbo loan, you're probably a high income earner. Now, because you're a high income earner, you represent a potential opportunity to that bank. They want your deposits, they want you to bring over your investment accounts. They want you to bring other loans that you might apply for through that institution. And as a result, they will often sweeten the deal for some of these loans that are jumbo and non conforming. So while with a typical loan, you might have to put 20% down on that property to avoid PMI, if you have a jumbo loan and you have high income and high assets, you might find a bank out there that will say that you can make a 0% or a 10% down payment on a property. And even though it's within 20%, it does not require you to pay PMI. But the flip side of that coin is they will likely also have several other things they want you to do, like moving your deposits for direct deposit to that bank, like having a minimum amount in your checking or your savings accounts at that bank. Like paying your mortgage every single month through the checking account you have at that bank. They're saying, we're going to sweeten the pot in terms of what it takes to get you in this property in exchange for getting more of your business above and beyond the home loan. So when you're evaluating your options, and remember, when it comes to things like this, I always encourage you to get at least three quotes. I would also encourage you to look at your local banks, look at your regional banks, look at boutique banks who may want your business, because you might find the right marriage of a loan that fits your needs without requiring PMI payments, but also a bank that can offer you some opportunities in exchange for that Sweden deal. The second reason in some cases that I think that the benefits of a 20% down payment are wildly overstated, is because of what we talked about before the break. PMI payments are heavily dependent on the credit score of the borrower. Now, going back to our example, I would agree that if you're in a situation where you have some credit score that's below 700, and when you look at what your PMI, um, payments will be, they will be hundreds of dollars per month, then it may not make sense to avoid putting 20% down on a property and choose to pay PMI if you have the ability to keep it off of your home loan. But going back to the initial example, where we have a person with a $400,000 home, a 10% down payment, a credit score above 760, and a 7% interest rate, we show that while this is not no money, it's costing them dollar 138 a month, and $13,000 in total over the course of eight years. But you have to compare that $13,000 that it cost them to what they were able to keep by not pursuing the 20% down payment at a $400,000 home value, 10% is $40,000, 20% is $80,000. So when they're trying to avoid paying $135 a month in PMI, the only way that they can do so in this example is to give their lender an additional $40,000. And if I can agree that dollar 138 is not no money, you should be able to agree that $40,000 is definitely not no money. And you have to think about that $40,000 and how you would use it. So let's say that this person did not give that extra $40,000 to their lender, and maybe they took half of that $40,000 and put it in emergency reserves or use it to pay down debt or use it to do some renovations for that house. But let's assume that they took the other half, the other $20,000, and they put it in the s, p 500. And we're going to assume that they put this in the s and p 500 in June of 2014, and they kept it in the market for ten years ending in June of 2024. So you can see on screen, and we'll put this calculator in the show notes, a $20,000 starting amount that stays in the market with no additional contributions for the ten year period. And you can see that at the end of that ten year period, the $20,000 that they contributed grew to $63,706 by the end of the decade. And even if you consider the $13,000 in PMI payments that they had to make by keeping this money on the sidelines, this still would net them an additional $50,000 in their investment accounts that they would not have had, had they given that money to their lender. And that brings me to the last reason that in many cases, when I'm dealing with high income professionals who have kids, who they're trying to educate and maybe have a parent that they're responsible for financially to make the smallest down payment that they can on their property, it's not that I want these people paying through the nose for their home loans. And yes, I know that if you make a smaller down payment, it's costing you more to pay for that home over the course of the 30 years. But you've also heard me say, ad nauseam, that financial decisions do not operate in a vacuum. Every single thing that you do in one area of your finances impacts another area of your finances. And if you're looking at this home loan and all you're seeing with your tunnel vision eyes is if I don't put this big down payment on my property, it's going to make my payment higher, and I'm going to pay so much more for this property over time. Here are some things that you can miss. Let's take a young family who has young children, and they're deciding they're going to send those kids to private school. And at the same time that they're sending those kids to private school, they're buying a home that's likely a significant upgrade from m the home that they came from. Not only is the mortgage payment higher, but the space is bigger, the upkeep on that home is higher, and now they have private school payments. Maybe you have a special needs child, maybe you don't have children, and you have a family member that you're responsible for financially. Maybe you're trying to acquire other things, like buying into a partnership at your law firm or something of that nature. There's all these things in that middle period of your career that, as odd as it may seem for a stretch of your life, can actually make it harder to save than when you were making less money. Like, there's these stages of your career where it's like, right when you start working, you're making no money. And then for many of us, there's a period before we have responsibilities of, uh, family members or marriage or children, where we're making a little more money, but we don't have that much responsibility. And that's when we started building up our emergency reserves. Building up our emergency reserves. And then we get married, and then we pop out a child or two, and then people get sick, and you have to care for those things, and then you do have to put money towards things that you did not expect. And in this period, you're making way more money than you've ever made before, but are somehow harder to save than right before those responsibilities came into your life. And that period can last for 510, 15 years in some cases. And during that stretch of time, it can be much harder to establish that extra $40,000 that you decided to put on your down payment than it was before you got into that new home, before you sent your kids to that school, before you made those decisions. And because it's much harder, you can't just willy nilly throw away opportunities to take things like the proceeds from your previous home sale and stick a portion of it in the market, because if you decide to do away with that opportunity, you may find that the money you chose to contribute as a down payment could have been working for you in the market during that same period. And because of all of life's pressures, it's harder and harder to replace those funds on your own. So if you're hearing this episode and this is not your life, sage, am I saying that you should definitively make a small down payment and choose to pay PMI absolutely nothing? If you're in this situation and you do have all these responsibilities of life, but your cash flow is still strong enough and you can invest enough where you can kind of have the best of both worlds, should you follow this strategy? Maybe not. But if you're listening to what I just described over the last two minutes, and that is your exact circumstance, or your potential exact circumstance when you try to get that next home, I want you to think about that when your lender says, hey, if you give us 20%, you can avoid PMI, but all you're required to do is 10%. Give it a strong thought before you make your decision. And if 10% sounds more palatable and you have the ability to keep some of that equity on the sidelines for other financial goals or other financial needs, don't feel like you're the crazy person in the room. I'll see you next week.
[00:21:54] Speaker B: From new money new problems this was the new Money New Problems podcast, a show for successful professionals searching for the tools they need to navigate financial opportunities and obstacles they've never seen.
