Don’t pay it. Get creative for your down payment. Here’s a brief on how PMI works and how we avoided paying it.
What is PMI?
A lender typically requires PMI when the loan is greater than 80% of the loan-to-value (LTV) ratio because it’s higher risk for them. If a buyer has less of their own money as equity in the property, the bank views this as a higher probability the homeowner will default on their loan. With that, the PMI is required until the borrower reaches at least 80% for the LTV ratio and the loan is in good standing for at least 5 years. This typically means that a borrower needs 20% of the purchase price as a down payment. There are a few exceptions, but overall, if you don’t have a 20% down payment, you’ll be paying PMI.
PMI can be up to 2% of the loan balance. The lender uses your credit score/history, the down payment amount, and the loan term to evaluate your risk and set the PMI rate.
While there are requirements that the PMI must be removed when your loan hits 78% and 5 years in good standing, you can request the removal of PMI earlier if your house value has risen (e.g., market fluctuation, improvements you made). If you request the removal of PMI, you may be required to pay for the new appraisal, which is an added cost. You should weigh the cost of the appraisal against the remaining payments. In a broad example, if the appraisal costs $450, and your monthly PMI is $120, then as long as you have more than 3 months left before hitting the 78% LTV ratio, it’s worth paying the appraisal fee to have PMI removed. There is also a risk that the appraisal doesn’t come back with a high enough house value, so you should be confident in your home’s value before requesting said action.
How did we avoid paying PMI?
While we were more than qualified to purchase a home in the D.C. suburbs based on our debt-to-income ratio, we restricted ourselves to what we could afford as the down payment.
A bank qualifies you based on your debt-to-income ratio. If you have low recurring monthly bills, then you’re qualified for a larger loan. At the time, our only recurring monthly payment was on my vehicle, at about $350/month. The bank pre-qualified us for about $700,000. Sure, we could “afford” a monthly payment on a $700,000 mortgage, but then we couldn’t eat, sit on furniture, or do anything else. 😉 We’d also be paying PMI because we didn’t have 20%, or $140,000, to put down.
Also due to our low debt-to-income ratio, we couldn’t qualify for any programs that would allow anything less than a 20% down payment for a mortgage. We set our purchase limit at $350,000, which meant we would need $70,000 for the down payment, plus closing costs. Due to the limited inventory at that price in the DC suburbs and the knowledge that we were pre-qualified for double what we were searching for, our Realtor kept pushing us to raise our purchase price. However, we advocated for ourselves and kept our focus on what we could afford as our down payment so we wouldn’t pay PMI. After months of searching and seeing places that were literally missing floors and walls, we increased our search to $400,000, hoping that if we found something in the 350k-400k range, we could negotiate it to 350k.
Our move to the D.C. area was not in our original plans. Mr. ODA had been saving through high school and college, expecting to buy a house in a lower cost of living locality. When we moved to D.C., we knew that we would need to change our expectations and day-to-day actions. We rented an apartment in Fairfax, but we didn’t want to be putting over $1600 per month towards rent for long, and we’d prefer to be paying towards a mortgage and building equity in a home. Positives to owning a home: mortgage tax deduction, appreciation, and the equity building that you get back when you sell the home.
While we rented, we were conscious of our spending. We aimed to spend less than $10 per day on food between the two of us, and we limited how much we ate out. We did activities with Groupons or restaurant.com coupons.
We moved to DC in December, and over the summer, we put an offer on a flipped foreclosure. The listing was $384,900; our offer was $380,000 with $2,000 in closing costs. It was denied by the bank, as we were told we were the 2nd best offer of 3. The next day, we got a call that the bank countered our offer. Apparently, the first offer attempted to negotiate their offer further, and the bank moved on to us. They countered $380,000 with no closing costs; we accepted. We now had to scrounge up about $80k for closing.
We looked into a Thrift Savings Plan (Federal government’s 401k) loan. Many warned us against the idea, but our research showed it wasn’t as much of a concern as others let on. The details of this loan option are on another blog post. We decided to each take a residential loan from our accounts. I took a $15,000 loan and Mr. ODA took a $25,000 loan. We also borrowed $5,000 from Mr. ODA’s parents and paid it back within a couple of months. We avoided PMI.
An argument heard about not owning a home is that it costs a lot to maintain a home. While owning the home for 3.5 years, we gutted the main floor bathroom ($4,000), replaced the AC ($3,600), replaced the hot water heater ($1,100), resolved termite issues with treatment and wall replacements ($2,000), laid carpet in the basement living area, improved the yard through grass maintenance and purchased a shed, and painted a few rooms. We sold the home for over $60,000 more than we purchased it for (tax free since it was our primary residence the whole time), far more than the minimal expenses we put into it.
Key takeaways from our experience:
- The efforts we put in to avoid paying PMI meant we had another $100-200 in our pockets per month. Instead of padding the bank’s ‘pockets,’ we paid ourselves back with interest into our retirement account.
- We lived below our means, saved, and kept focus on the big picture.
- We pushed ourselves to our financial limits to begin building equity in a home, rather than paying rent to a landlord (or in our case, an apartment company). The efforts put in that year have paid off time and time again, starting with selling the home 3.5 years later for a profit that led to some of our first rental purchases.