Becoming a homeowner for the first time can be a daunting undertaking. You have to figure out where the money for your down payment is coming from. You have to decide what kind of mortgage you’ll qualify for. You have to get your finances in order. Then, when you are finally ready to venture into the marketplace, you often have to compete with other buyers—some of whom are armed with tons of cash and don’t need a mortgage.
I have covered in earlier articles some ways of meeting the challenges of being a successful buyer. I have also written in some detail about mortgage insurance—a necessity for buyers who don’t have a 20% cash down payment. Today I’m going to explore a long-term strategy for buying with a small down payment, and how to minimize your cost of ownership over the long term.
Waiting to save up enough cash for a down payment is an expensive proposition today. For one thing, with real estate values on the rise again, you will pay more for your home in the future than you will pay today—a lot more. I explored those numbers a couple of weeks ago.
There are plenty of ways for you to buy today with a very small cash down payment. If you meet certain income requirements, for example, you can become a home owner with as little as .5% down, or you can get a conventional mortgage with a down payment as low as 3%. These programs allow you to buy much sooner, before prices get out of reach.
When you make a small down payment, you will have to pay mortgage insurance (MI). The cost of that insurance will depend on your credit score. If your FICO is 740, you will pay 1.15%. That amounts to $186 a month for a $200,000 purchase.
MI is a sort of performance bond designed to protect the lender against loss if a borrower defaults. Once the loan is 80% of the property’s value, you can have the insurance removed. The key is to pay attention to the values in your neighborhood; the lender will not call you and say, “Congratulations! Your home has gone up in value, so you no longer have to pay $186 a month for mortgage insurance!” You have to be proactive.
You should keep track of your balance each month (it will be on your monthly statement). To determine what you home should appraise for to remove the MI, divide the balance by .8. That number will tell you what your home has to be worth in order for the loan to be 80% of the value.
The balance on your $196,000 loan will be $192,400 in one year. Dividing by .8 gives you $240,000. That’s what your home must appraise for in order to remove the MI. That is 12% higher than what you paid for the property. In today’s appreciating market, that’s not far-fetched. If you’re not quite there, take another look at the value in 6 months. Your loan balance will have been paid down to $190,500, and you will have had an additional 6 months of appreciation. The value needed will be $238,000.
You can keep track of your home’s value by staying in touch with your Realtor©. He or she would be more than happy to see what homes in your area have been selling for—and will be delighted to be your hero by providing this service.
The lender will require a full appraisal to document the higher value for your property. Before you invest the $400 or so on the report, contact the lender to find out what their procedure for MI removal is. They may have some additional requirements, and you want to be sure you follow them exactly.
Mortgage insurance is a useful tool that can allow you to become a homeowner much sooner and at a lower cost than waiting to save a large down payment. You will minimize your cost of ownership over the long term by being aware your home’s value and getting the MI removed as early as possible.