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   ARTICLE   |   From Scotsman Guide Residential Edition   |   August 2017

Cure the Downpayment Blues

Private mortgage insurance can open the door to affordable financing

As a mortgage originator, you likely hear this often from potential homeowners: “I want to buy a home, but how can I possibly come up with a 20 percent downpayment?” Data show that many people buy homes with a much lower downpayment, however.

In fact, 80 percent of first-time buyers fall into this low-downpayment category. Although there are different types of low-downpayment options that make this possible, a conventional loan with private mortgage insurance (PMI) has proven for 60 years to be a steadfast and smart way to bring homebuyers to the closing table.

Mortgage insurance (MI) protects lenders from defaults, providing creditworthy borrowers access to mortgage credit despite a low downpayment. This is a tool that can help originators expand the canvass of financing opportunities.

Qualifying for a low-downpayment mortgage can provide a homebuyer with greater purchasing power. MI helps individuals get into homes and build equity sooner. In addition, borrowers who don’t put all their money toward a downpayment have additional money for home improvements, savings and other life expenses.

Awareness gap

People who sit on the sidelines and don’t take advantage of low-downpayment programs that use MI will spend more money on rent, delay the potential of home-price appreciation, forego the tax advantages of deducting mortgage interest, and could miss out on historically low mortgage rates.

High rents and low interest rates should be enough to convert more people into potential homebuyers, but low-downpayment options can add that extra selling point that tips the balance — if they know these options exist. The fact is, however, many would-be first-time buyers are unaware of these opportunities.

A recent Wells Fargo survey of some 3,400 adults showed that 40 percent of respondents did not know they can qualify for a mortgage without a 20 percent downpayment. In short, a 20 percent downpayment should not be a barrier to homeownership.

Two of the most common low-downpayment loan options are conventional loans with PMI and loans guaranteed by the Federal Housing Administration (FHA). A conventional loan with PMI can be more attractive because it requires a borrower to put as little as 3 percent down, while the FHA requires 3.5 percent. That may seem like a negligible difference, but it is an additional $1,000 on a $200,000 purchase that can be extra purchasing power or applied to closing costs or home improvements.

Greater flexibility

Some have called MI an added expense, but they forget that mortgage insurance is the reason these homeowners qualified for a mortgage in the first place. Without a larger downpayment, it is more difficult to obtain safe, affordable financing. What makes PMI even more attractive is that its premiums are temporary. This is a major benefit that PMI has over FHA mortgage insurance: private mortgage insurance can be canceled.

Mortgage insurance protects lenders from defaults, providing creditworthy borrowers access to mortgage credit despite a low downpayment. 

PMI terminates automatically after a homeowner reaches 22 percent equity in his or her home. It also can be canceled upon request by homeowners when they reach 20 percent equity. And when PMI is canceled, the homeowner’s monthly mortgage payment naturally goes down because the monthly insurance payment goes away. Homeowners potentially can save many thousands of dollars over the life of their mortgage.

There are not many other low-downpayment mortgage options that offer this kind of upside. In contrast to PMI, mortgage insurance premiums on FHA loans generally cannot be canceled and are paid throughout the life of the loan.

More possibilities

Borrowers have some options when it comes to the type of MI premiums they choose. The most common is called borrower-paid MI, which is paid monthly along with the standard mortgage principal and interest (P&I) payment. This is the MI that can be canceled, because it is paid each month as a separate line item versus being financed into the mortgage. Even so, borrowers may opt to pay their full insurance premium at closing, but this does require more cash in-hand.

FHA mortgage insurance premiums, on the other hand, are generally known as split-premiums. This is because one portion of the FHA insurance is paid “upfront” at closing or typically financed into the mortgage. Currently this up-front premium is 1.75 percent of the total loan amount. The rest, called the “annual premium,” is paid in monthly installments similar to conventional PMI, except that most FHA annual premiums can never be canceled short of paying off the loan or refinancing it.

What’s more, a conventional loan with PMI can translate into added purchasing power. With downpayments as low as 3 percent, homeowners can have more capital to work with as they search for home that is big enough to start a family or has a more desirable location. By giving homebuyers more choices in a safe and responsible way, PMI creates more possibilities for people.

The cash freed up by low-downpayment options created by PMI also can be used to increase the value of a home. The funds saved by taking out a mortgage backed by PMI can be used toward home improvements, like expanding a kitchen or building an addition. These investments into the home can then result in home-price appreciation. There also are buyers who simply do not want to enter homeownership “cash poor” and sleep better knowing they have a rainy-day fund or money that can be used to cover other expenses.

Tested and reliable

The homebuying process can be exciting but unsettling. Thankfully real estate professionals — including mortgage originators — serve a unique and essential role in educating homebuyers and dispelling the myths about downpayment requirements, such as the misconception that a homebuyer must put 20 percent down to qualify for a mortgage.

Since 1957, private mortgage insurance has served as a reliable and affordable way of expanding homeownership by helping millions of families get into homes. This tried and true low-downpayment option will continue to help millions more in the future.


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