I’ve had a lot of people ask me if they should use their savings to buy a primary residence or a rental property. As usual, the answer is “it depends.” And in this case, maybe the answer is “do both!”
At a recent event, a young couple came up to me and told me they had saved $200,000 to buy a home. First of all, I was so impressed! Few people save money today. Then I asked if they had started house shopping yet and if they could afford a home they’d want to live in for a long time. They told me it wouldn’t be their dream home. It would just be a condo.
Here was my response: If you want to live in a home for a long time for something like raising a family, buying can make a lot of sense if you find a nice community with good schools. The mortgage payments may be a little more than what you’d pay for rent, but when you include the tax benefits, that home loan can be cheaper than rent. Plus, if you have a fixed-rate loan, you don’t have to worry about your rent going up. It will remain the same for the life of the loan.
However, what if you could buy the home you want to live in with a smaller 3% down payment and use the rest of the funds to buy rental property? The cash flow would offset the difference in your mortgage payment, and you’d be building a bigger portfolio.
Lindsey Johnson, President of US Mortgage Insurers, will take a deep dive into mortgage and home financing options, and give us some insights on current public policy on housing and its ramifications on home buyers and investors.
Podcast Transcript : Low Down Payment Loans with Mortgage Insurance
Kathy Fettke: Lindsey, welcome to the Real Wealth Show.
Lindsey Johnson: Thank you for having me, Kathy. I’m excited to be on and I appreciate the opportunity to talk to you and your listeners.
Kathy: Wonderful. Well, let’s talk about mortgage insurance and what it is.
Lindsey: Absolutely. Mortgage insurance is really there for borrowers who are unable to put a down payment of 20%. These borrowers are typically viewed by lenders as higher risk and so, private mortgage insurance enables the borrowers to qualify for conventional loan by insuring that the lender was not going to have to eat that loss in the event that the borrower can’t repay the loan and there’s not sufficient equity in a home to cover the amount its owed. We’ve existed for 60 years and in that six-decade period, we’ve helped more than 30-million individuals become homeowners sooner than they otherwise would be able to.
Kathy: There’s a lot of talk that people say, “It’s dangerous to have low down payment loans, we could have another housing crisis.” What’s not discussed so much in that discussion is that there’s almost always mortgage insurance if 20% down payment is not made?
Lindsey: That’s exactly right. Yes, there is higher risk when you compare someone who’s putting less than 20% down to somebody who’s got a full 20% down payment. However, that’s the reason that mortgage insurance exists and we’re not some fly-by-night industry. We’ve existed for more than 60 years. As I mentioned, helped more than 30-million people get homeownership sooner than they otherwise could.
If you think about the financial crisis, the ultimate test to the industry, we paid more than 50 billion in claims. Those are claims that otherwise would have been paid by Fannie Mae and Freddie Mac and ultimately, the taxpayer. We played an incredibly important role during the financial crisis and just on a day-in-day-out basis, where they’re protecting lenders and Fannie Mae and Freddie Mac in the event of a default.
Kathy: It’s amazing that you guys are still in business after the last crisis. [chuckles] I would think that that would have been a pretty hard hit.
Lindsey: It was a crazy time for [chuckles] everybody. Absolutely. Really, is the testament to the strength of the industry. This is a highly capitalized, very well-regulated industry that really understands and has expertise and experience managing mortgage credit risk. That is its long tail risk, so it’s a different form of risk than many other types of risks that are out there. That’s why they’re very specialized companies that do this.
Who Qualifies for a Low Down Payment?
Kathy: What kind of buyer can get a low down payment mortgage and get the mortgage insurance? Is it just residential or can you do it for investment property?
Lindsey: Just residential. We think one of the most important things that we’ve been trying to educate folks and I know a lot of your listeners are more sophisticated, but one thing that we have found is that, even some of the key stakeholders within the mortgage finance system don’t truly understand mortgage insurance and don’t understand the different low down payment options that are available.
Consumers definitely don’t. We are continually surprised and in fact, all of my member companies are disappointed when they hear on a day-in and day-out basis consumer site, one of the number one obstacles and the reasons that they’re staying on the sidelines and not purchasing is, they don’t have enough for a down payment and closing cost. In fact, there’s just report released this summer by Freddie Mac that said, nearly half of all non-homeowners state, not having enough money for the 20% down payment and closing costs was their number one obstacle to purchasing a home.
Then when you look at the data behind those aspiring homeowners, you can see that they’ve got the resources and they’re absolutely home ready. What’s really amazing is that once an individual comes in and actually takes the step and many of them are staying on the sidelines, but once they take that step and actually meet with the professional, that more than 80% of individuals who obtained a home mortgage for the first time this past year had down payments of less than 20%. It’s not just something that a few individuals are doing. This is a prevalent thing within the mortgage finance system.
Again, our big push to do is just to make sure that individuals are aware of the down payment options available to them. You’ve got private mortgage insurance and obviously, we’re in the conventional space and you can get a mortgage with as little as 3% down. You’ve also got FHA or Federal Housing Administration loan, that’s the government backed loan and those loans go– you can get loan with as little as 3.5% down.
Again, just knowing your options and understanding what’s available to the consumer and making sure as a professional in this space that we’re sharing in and providing consumers with the right resources and tools is absolutely critically important.
Buying a Home with Just 3% Down
Kathy: I agree. I am always shocked when I tell people that they can buy a home with 3% down and they’re like, “What?” They have no idea. I guess we have more work to do to get the news out because, obviously, as you said, it’s not new news, there’s just a stigma or a belief that you have to have that 20% down payment or that it’s dangerous to buy a house if you don’t have that, which again, I disagree with.
What I think is more important than how much you put down is your ability to make the payment. In the past, in 2006, people were getting approved for payments that they actually couldn’t afford but that’s not the case now. Even if you put 20% down and couldn’t afford the payment ongoing, you’d find yourself in trouble. Whereas today, it seems like, especially where I live in the Southern California area, believe it or not, rents are so high right now that is actually cheaper to own in some areas.
Lindsey: Absolutely. What’s amazing to me, I vividly remember my dad grilling it in my head that before I ever even thought about walking into a lender’s office, I better have 20% down, I better have a perfect credit score, need to have this laundry list and that was extremely intimidating. Really, as I worked in this profession and worked in the policy area in this profession, it took me a while even then to understand, what really is required. Consumers need to know that to your point, it’s not always best, not always even most prudent to save for the full 20% down.
When I explain this to people, I love to use this example that one of my member companies walked me through. I think it’s so powerful. If you have someone and I always like to use an example, so if you have someone named Tracy that’s saving for a 20% down payment on a $200,000 house, and let’s say she saved for 10,000– she’s got $10,000 in the bank and she’s required to have $40,000 if she was going to save for that 20% down payment. Let’s just assume that because the national savings rate, we can do a little bit of this analysis and decide that she can save $500 that she would put in the savings each month.
That’s $6,000 a year. What she should know is that she could buy a house with as little as 3% down and that’s $6,000 compared to $40,000 and those people are putting between 5% and 7% down on their mortgage. If you’re putting 5% on a $200,000 house, that’s $10,000, that’s a $30,000 savings over that 20% down. What we really try to educate folks about in terms of looking at this for the long-term financial well-being is as she waited to put that full $40,000 down for that 20% down payment, she absolutely would miss out on some appreciation.
If you think about how prices are appreciating at roughly 3% annually and that number does fluctuate of course, depending on where she lives in the country, obviously, things can change over time but her future 20% down payment would need to be $48,000, actually more than $48,000 if she were going to save for that 20% down payment and based on that 3% appreciation annually. It’s going to take her six more years to save. During that time, she would have paid more than 80,000 in rent and her home equity position would have been more than $72,000 had she bought six years ago.
Again, this is a pretty simple example but as we walk folks through and we say, “Look at your savings rate. Look at what you’re able to put into savings and understand how long that’s going to take you to save for that 20% down and does it make more sense for you to hang onto some of that savings?” So that– to your point earlier, are sure that if you hit some bump on the road, that you’re able to cover that through savings and not in mortgage payment.
Invest Your Down Payment Savings
Kathy: Oh my gosh. I tell that to people all the time and I have family members who said, they tried to put 30% or 40% down. I said, “No, no, no, no,” because they wanted the lower payment and I thought you’re in a much more secure position if you put less down and hold the difference in savings or in a short term investment so that if you need the money, if you ever run into hard times or medical issues, you’ve got something to help you make that payment versus, now it’s all in the home equity and you can’t get it out as easily.
Lindsey: Absolutely, and having that prudent savings and being able to use it for things like renovations or appliances or furniture, medical expenses that you just weren’t expecting. Those are just as important as making sure that you are able to make that monthly payment. Just making sure that you’ve looked at all those different options and considered it from those different angles is really important.
Mortgage Insurance Does Not Tie You Down
Kathy: Absolutely. Good stuff. One problem today with first time home buyers is many of them are millennials and we’ve all heard that millennials do like to travel or move. They’re not necessarily interested in settling down in one place for the rest of their life. If a millennial, a first-time home buyer in their early 30s say does take advantage of a low down payment and mortgage insurance but they have to move in say two years, can they?
Lindsey: Absolutely. There’s nothing that is really special about mortgage insurance that would tie an individual down. It is as seamless to the mortgage process as when you go in and you purchase your mortgage. When you go in and you don’t have the full 20% down payment, you will be required to have mortgage insurance either through FHA or through private mortgage insurance and it’s typically built into your monthly payment. So, whenever that individual goes to sell their home, that would be the same process as if they didn’t have mortgage insurance. Absolutely.
Kathy: If they want to keep the house because they have to go away just for a year or two, can they rent it out during that time?
Lindsey: Yes, absolutely. As long as they’re able to cover their rent and obviously, that would be important no matter what. They definitely can rent their house out, absolutely.
Mortgage Insurance Helps First-Time Buyers
Kathy: Okay. All you millennials listen in here, [chuckles] this is such important information. People listen to this show because they know they can build wealth through real estate but often feel they can’t get that first property and the point is, you can, you don’t have to live in the property forever. If you’re worried that your job might transfer you or you might lose your job and have to work somewhere else, you don’t want to be locked down, you’re not locked down. It’s a way for you to get into a property with a low down payment, 3%.
You do pay more because there’s mortgage insurance but if you check what the local rents are such that if you are in a position where you have to leave and might have to rent that house out but the rent still covers the mortgage payment and the mortgage insurance, it’s definitely something to consider. It’s exactly how my daughter got into her first property. It was a 3% down type loan and she did end up moving closer to me and has that property rented for quite a lot of cash flow.
Lindsey: Well, and you said something a moment ago that really I want to emphasize. The other amazing thing with mortgage insurance is that your payments over time can go down because after an individual has built up enough equity in their home, usually it’s 20%, mortgage insurance goes away and the payments related to mortgage insurance go away. That’s not true for FHA loans, but for private mortgage insurance loans, we are cancelled at 20%, it’s required and the payments go away.
Over time, borrowers typically love the fact that they are going to see their payments actually go down. On average, that’s between five and seven years. A lot of individuals really see this as a short-term solution to making sure that they’ve got longer-term wealth prospects in the future.
Kathy: Now, I had heard that there was talk that FHA might change its guidelines on that for so many people who now do have more than 20% equity, even maybe 30% or 40% equity and they’re still paying that mortgage insurance. Do you see any movement there where potentially FHA loans might be able to drop the mortgage insurance?
Lindsey: We don’t see anything yet and there has consistently talk about that issue. One of the differences between private mortgage insurance and FHA insurance and the reason that PMI cancels is because the insurance actually goes away, but for FHA insurance, the insurance never goes away. Even if you were to say, “cancel the insurance payments,” the insurance is still there and I have a hard time thinking that the federal government wants to be exposed to that additional risk and continue to back those loans if they’re not going to get this steady income or premiums from those loans. We hear the same talk but I don’t see anything happening anytime soon.
Kathy: Well, too bad for all the people who are paying a lot more but at least you got the home equity. You can refi, get out of that FHA loan. Good time to refi. Where can somebody find a 3% down loan that’s not FHA?
Lindsey: That’s a great question and it all depends on the individual’s credit profile but, when you go inand for lenders and brokers and mortgage bankers, these are really important options to know. Many if not most know about these but understanding that Fannie and Freddie have these approved programs now that offer as little as 3% down and talking to your loan officer and doing that math. We actually put information out there all the time about “do the math, really look at what your savings would be.” If you’re putting 5% down versus 10% and even 3% down versus 10% and in the longer term, does that make sense?
All lenders should be apprised to these different loan offerings because they are standard through Fannie Mae and Freddie Mac who are the GSEs that offer these different guideline programs. We think that just making sure that as an individual walks in, that is not set in stone, this is what I’m going to do. Have that conversation with them, make sure that they really understand the different options and have considered the different impacts on not just their payments but in terms of longer term financial picture.
Mortgage Broker or Bank?
Kathy: Do you think it’s better to go to a mortgage broker or just walk into your local bank?
Lindsey: I think either one. Obviously, I think there’s going to be some distinctions in terms of maybe how the information is presented and a bank, usually has a very set-set of guidelines that they’re going to follow. Mortgage brokers oftentimes are going to be shopping around and so, they’re going to see some of the different, maybe even more options available for consumer based on their credit profile. I think either option is great, but going in as a consumer and knowing just a baseline of information that will help you be prepared for that conversation will be extremely helpful.
Because, when that broker or when that banker presents to you, “Here’s what we’re looking at,” you can ask those questions, “What about 5% down? What if I add 3% down?” I think those are key things that you want to make sure that you’re doing as a consumer and obviously, as a professional, you want to make sure that you’re giving your consumer the best options for them.
Kathy: I personally recommend going with a broker, especially if you’re just wanting to find out how much you can qualify for and what loan options are out there. They’re going to have a lot more insight because that’s what they do, they broker it, they have access to a lot of different banks. Rich and I just thought, “Let’s just go to our local bank where we do all our banking. They know everything about us. They know how much money’s in our accounts, we’re the platinum level or whatever and that this will be easy.”
It was so hard. Oh my gosh, it took months and finally we just walked out. I think the local bank could definitely be more difficult and I don’t want anyone to get discouraged, so maybe just talk to both, definitely talk to a broker because they will have access to more options.
Lindsey: Absolutely. Why this mystery can be so complicated mystifies me but it is complicated. I think part of our responsibility is connecting those dots and bridging those divides. We were a B2B industry but part of the rationale for you as my being so engaged in this conversation is because we do see how complicated it is. We do see not just the lack of information but the misinformation that is out there. Making sure that consumers know where to go to get this information and giving them their options and making sure that we break it down into the most digestible piece components for them, I think is absolutely where we need just all be trying to go.
Kathy: Excellent. Well, I really appreciate you being here and giving some insight to our listeners. This could be the light bulb moment for some people who are just not quite sure how to get in that first property.
Lindsey: Wonderful. Thank you for having me on and we appreciate everything that you guys are doing here.