You may have just heard or read that there was a surge in existing home sales nationwide this year. The anticipation is that the pace will pick up throughout the spring and summer (annual unit sales may be even greater than the best year of the 80s). You understand the law of supply and demand and think prices now have bottomed out and you should make your move to purchase before prices rise. And then, on March 25, came the Federal Reserve's decision that it had become necessary to raise the discount rate by a quarter of a percent to dampen inflationary pressures on the economy. So you say to yourself, "Now is the time to buy!"
You look at your savings account and it reflects a balance that no way would allow the purchase of the type of home you want. What do you do? What are your options? You can wait until you accumulate the funds. But, you know how difficult it is to save. You also know that the tax man is no friend of the non homeowner; what you save is taxed and so is the interest generated by your savings. The only tax break on today's 1040 is the mortgage interest deduction. Are there options? Yes! If you have income you can buy a home. In the past, lenders typically would want to secure their investment (the loan that they put on a property) by requiring the borrower to put down a substantial amount of cash usually 20% or more. As we know, many people have great difficulty coming up with a 20% downpayment. Enter the private mortgage insurance companies (PMI)!
We have heard of the term mortgage insurance. However, as I work with people there has been some confusion about the term. Many people think that mortgage insurance is life insurance. Mortgage insurance is not life insurance when the term is used in conjunction with the purchase of a home with a limited amount of money down (usually 3%, 5%, or 10%). Mortgage insurance protects the lender. It is an insurance policy for which you, the borrower, pay.
Usually you pay a monthly premium to insure the lender in the unfortunate circumstance that you default on your loan and the lender must take you through the foreclosure process. Your premium on this policy is determined by the downpayment. If you are putting down 5% your monthly premium will be higher than the borrower who is putting down 10%. The premium for an adjustable rate loan will be slightly higher than the cost of a fixed rate loan due to the fact the payments on the adjustable rate loan will change with market conditions. The borrower with an adjustable loan will not have the certainty of constant payments and the impact of higher payments may be detrimental to the borrower's ability to pay back the loan.
Even with the payment of a monthly PMI premium, a limited downpayment on a home does have certain advantages. If your income can support the slightly higher monthly loan payment, the interest deduction on your tax return will be greater since the loan amount is larger.
The cash that would ordinarily go to the downpayment can be used for furnishings, landscaping, or paying off any loans whose interest is not tax deductible. You could also keep the money as reserves against any contingencies you may find after your purchase. It is best to put the numbers on paper and determine which among the purchase options is the right way to go for you. You will also see programs emphasizing no PMI. Many of these programs will incorporate the PMI premium in the interest rate for the loan, usually at a rate of 3/8 of a percent above the loan rate. As stated, the best way to determine your path to financing a home is with a pencil in hand and evaluate your comfort level for the biggest purchase of your life.
Copyright © 1999, jjrmf.com