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Mortgage Insurance: The Basics

Mortgage Insurance generally has a negative undertone when I discuss financing with clients.  Most new homebuyers pay mortgage insurance in some form, either monthly, as a single-premium, or as lender-paid.  Unless you are qualifying as a conventional loan with 20% down or are a VA borrower, you will pay mortgage insurance.  But how you pay it can be an advantage, saving you money in both the short term and long term.  If you must pay mortgage insurance, let’s use it to our advantage.

Fun Fact

Conventional loans with a loan-to-value (LTV) less than 80% must pay mortgage insurance and will typically have a slightly lower interest rate than a loan with 80% LTV.  As crazy as that sounds, it makes sense.  Here’s why:

Loans that have mortgage insurance go through a second underwriting process through the mortgage insurance company such as MGIC or National MI.  This is a third-party underwrite.  In addition, the loan itself is insured against potential losses to the bank in the event of a foreclosure or short sale on the home.  The bank purchasing the loan will price the interest rate better than 80% LTV because layers of risk were mitigated and insured.  Think about it, the bank lends on risk/reward.

3 ways to pay PMI with Conventional Financing

Mortgage Insurance, for conventional financing, is priced/scored based on the borrower’s FICO score and LTV or down payment.  The better the FICO score, the better the pricing.  Each option comes with a list of considerations before picking which option is the best.  A later blog post will outline these considerations.

  • Monthly PMI – The most common method for paying mortgage insurance because it’s the cheapest in the short term.  Many borrowers pay the monthly factor and refinance once their home appreciates to having 20% equity.  There is no additional fee added to closing costs to have monthly PMI.
  • Single-Premium PMI – Becoming more common when borrowers have high FICO scores and are putting 10% or more down to buy a home.  This option “buys out” the monthly PMI and is tax deductible through 2020, for now.  Visit the IRS site for additional details.  A borrower can also refinance with single-premium PMI and include the cost in their loan amount if it makes sense.
  • Lender-Paid PMI (LPMI) – With LPMI, the lender pays the single-premium mortgage insurance on behalf of the borrower with a higher interest rate.  The result is no upfront expenses and no monthly PMI.  As some point, the borrower will want to refinance to get a lower rate, provided the equity is at 80% LTV to avoid any PMI.  LPMI requires a thorough review of a borrower’s profile to understand how their payment is impacted. 

FHA vs Conventional

Borrowers should note that monthly mortgage insurance is not permanent on conventional loans like it is for FHA loans with less than 10% down or less than 10% equity.  The Homeowner’s Protection Act of 1998 (HPA) mandates that PMI (mortgage insurance) on conventional financing must drop once the loan amortizes to 78% LTV.  On FHA, you must refinance (or payoff your mortgage) to eliminate the mortgage insurance for any new loans originated today with less than 10% down. 

However, it is possible to request the Mortgage Insurance company to drop your PMI before your loan amortizes to 78% LTV if you have a conventional loan.  If the equity in your home has appreciated to 75% and you’ve held the PMI for 2 years, you can request the Mortgage Insurance company to perform an appraisal to show the value is 75% LTV.  Some of my clients have been successful in this approach.  They can keep their first mortgage terms such as the interest rate and remaining loan term.  A good mortgage advisor will be able to help you forecast expectations and plan reasonably for different considerations.

Summary

Mortgage Insurance enables First-time buyers and seasoned homebuyers to access homeownership without breaking the bank.  The overall cost of PMI is minimal compared to the equity gained over a short period of time.  It allows consumers to keep additional cash, otherwise used for the down payment, in their saving accounts and budget responsibly for homeownership. 

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The Hidden Cost of Renting

A long time ago, before I ever worked in mortgage finance, I moved 5 times in one year between apartments and friends homes.  I finally landed living with my Grandparents so I could finish school and afford my bills.  I struggled financially and was truly grateful for my Grandparents taking me in.  I finished school and later moved out shortly thereafter.  But all those moves taught me something valuable; renting and moving are expensive.

Granted, the average family is not moving 5 times in a year.  In fact, they may move once every year or two.  While my expenses added up much faster, it occurred to me that even the one move or continuing the rent cycle adds up overtime both in dollars actually spent and missed opportunity with rising interest rates and home value appreciation.

Convenience

Renting a home can be more convenient for a number a reasons; A Landlord takes care of major repairs, you are not committed to living there permanently, and sometimes it will be less expensive in the short term.  Yet, the same considerations for renting can translate into homeownership becoming a better option for convenience. 

As a homeowner, you are your own Landlord.  You will need to maintain your home.  But YOU maintain your home to YOUR standards, not sub-standards to save a couple bucks.  YOU control the level of work done with repairs and maintenance.  I have heard countless stories of how Landlords fixed a broken water heater or dishwasher with a used one as the replacement for the appliance to just give out on them a month later.  Another story involved a leaking roof that the landlord did not fix properly which later created black mold issues in the home.  While you are responsible for your home, the quality of life can be much better.

Rental Rates on the rise

According to an Inman article with CoreLogic data, rental rates increased 6.9% in 2018 in Phoenix and 3.1% Nationally due to job creation and limited supply for housing.  Phoenix is listed as one of the top markets for cost of living affordability and economic growth.  This means owning a home and/or buying a home in 2019 will still help you take advantage of an appreciating market when values increase. 

The housing demand is noticed locally in the Phoenix market with many new home projects underway.  That’s because both single-family homes and rentals are in such high demand for new families, growing families, college graduates, divorcees, and retirees.  Between rising rents, right-sizing and job growth, people are looking to fix their monthly expenses while leveraging wealth creation.

Looking at the Numbers

Let’s dig deeper at the numbers.  Take a 3 bed 2 bath single-family home valued at $250,000 in a neighborhood.  Rent is $1,600 per month.  Below are additional expenses:

Security Deposit: $500

Pet Deposit: $300 (if applicable)

First Month’s rent: $1,600

Moving: $1,500 – $3,000

Total: $3,900 – $5,400

Cost of Waiting

Your total cost of entry is nearly 75% of the down payment needed to purchase a home.  And, you “skip” a payment when the mortgage comes due.  When you try buying that home in a year or two, you will likely pay more for the home which will increase your cost of entry and the monthly payment due to rising rates and appreciation on the home’s value.  Appreciation occurs when the supply is lower than the demand.  Homes in this price point are hot in today’s market.  See below:

The chart above depicts the historical appreciation in Maricopa County.  The conclusion to consider is how much more you will pay for every year you decide to wait.  The appreciation of home values makes the cost of entry higher.  If rental rates are themselves expected to increase, why wouldn’t home values increase?  Remember, there is a supply and demand issue. 

Amortization is a way of spreading out the cost of something.  For housing, it means payments of money owned/borrowed (principle) and the cost of money (interest).

Looking at amortization (principle payments) and appreciation combined, you start to see how owning a home creates wealth.  The cart below depicts how overtime the money you are paying into a home works for you.  After year one, you would gain $15k in ownership.  This combines the money paid toward your principle and the equity gained.  In year two, that number doubles to $30k.  Paying $1,600 per month towards rent ($19,200 over 12-months) goes toward zero.

Summary

As a lender, it is obvious I am a proponent of homeownership.  Afterall, it’s my business.  I am not opposed to why someone will continue renting and in some cases, I may recommend that setup.  However, I wouldn’t be doing my job if I didn’t take the time to explore the numbers and overall breakdown of how and why homeownership is a better solution, even if the payment is a little higher than renting for the short term. 

Ultimately, any decision requires some emotional and rational thought process.  If you can afford a rent payment that equates to a mortgage payment, you are truly missing out on opportunity, even if it’s for the short term.

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Evaluating a Down Payment Assistance Program

When I first started as a Loan Officer, Down Payment Assistance (DPA) was all the rage.  Many prospective Home Buyer’s were coming out of the recession with great income and decent credit, but lacked the assets for a down payment.  In addition, home prices were so low that just about everyone could afford the monthly payments and the terms associated with DPA’s. 

Fast-forward to 2019, changes in DPA programs have altered it’s allure and now it’s important to consider how using a DPA will impact your financial future when purchasing your home.  In this post, we explore the various DPA programs, their requirements, the monthly payments, and future considerations.  It’s a lot of information, but well worth the read if you are considering a home purchase in the near future.

*Loan parameters are based on Rates and terms as of 2/1/2019.  Conventional Financing terms based on a 720 FICO score and the Fannie Mae Homeready Program with 3% down payment.  Program terms and rates consider coverage variations prescribed by Fannie Mae Homeready, HFA Preferred, Home In Five, and Home Plus.  FHA Financing terms based on a 660 FICO score. NMLS# 1074188 All Borrowers subject to credit qualifications. Not all borrowers will qualify as certain restrictions apply on all programs. The information contained in this material is not a guarantee to extend credit or lend. Terms & conditions are subject to change without notice.

What is a DPA & what types are offered?

The DPA programs mentioned here are offered in Maricopa County Arizona.  They grant certain percentages of the purchase price on a home in the form of a silent second lien towards the down payment needed.  Home in Five offers special incentives for Teachers, First Responders, Veterans, Military, and Nurses.  Home Plus allows additional funds as a down payment towards your purchase.  Below is a brief list:

  • Home in Five Program
  • Home Plus Program
  • Pathway 2 Purchase
  • Neighborhood Stabilization Program (NSP) – Through a respective City
  • Matthew Hensen Program (tied to NSP)
  • Chicanas Por La Casa

For the sake of time and popularity, we will discuss only the Home in Five and Home Plus programs. 

Home in Five

The Home in Five will grant up to 4% assistance to cover the down payment and/or closing costs on your new home.  The 4% is the max allowed provided you meet the requirements for credit and qualify for the special incentive.  There is a maximum income limit allowed of $99,169 unless you are using the Fannie Mae HFA Preferred portion of the program which is $69,100.  The maximum debt-to-income ratio allowed is 45%.  That means your total obligation (including your proposed house payment) cannot exceed 45% of your gross income used to qualify for a mortgage loan.

Your assistance is calculated off the BASE loan amount after a down payment would be applied.  For example, Buying a home at $275,000 with FHA at 3.5% down using this program, the BASE loan amount is $265,375.  If your max assistance is 3%, the grant will be 3% of $265,375 or $7,961.25 as your grant.  You would still need $1,663.75 for the remaining down payment which can be a gift or come from your own funds.

Source: https://www.ehousingplus.com/wp-content/uploads/PMIDA-HOME-IN-5-FINAL-Guide-01-09-19.pdf

The grant is now considered a forgivable silent second mortgage loan or lien.  There are no payments due on this second lien for 36 months.  You will be required to pay back the pro-rated portion of the silent second loan if you payoff the original first mortgage before 36 months; i.e. a refinance, selling your home, etc.  After the 36 months, the silent second lien drops and you no longer owe those funds.

Finally, the interest rate for the Home in Five program is pre-determined for you regardless of your FICO score.  The program administrator and master servicer set the terms for the rate.  As of 2/1/2019, the rate was 5.625% for the FHA and 5.75% for Conventional & VA.

Home Plus

Home Plus is very similar to Home in Five except the debt-to-income ratio allows up to 50% and the down payment grant can go from 0% – 5%.  However, the more you receive, the higher the pre-determined interest rate.  In addition, the income limit is much lower, $66,100.  Both programs do NOT require you to be a first-time buyer and you are allowed to own other property.  You must occupy the home you are purchasing as your primary residence within 60 days when using either program.

Source: https://lenders.housing.az.gov/

Quick Fact

You may be wondering (or not in which case skip to the next section) what is HFA Preferred?  House Finance Authority is a designated department of a State government agency in charge of administering and managing grants for homeownership.  Fannie Mae & Freddie Mac give a special discount on mortgage insurance when you originate your loan through a HFA.  Arizona’s HFA is represented through the Industrial Development Authority of Maricopa County.  True homebuyer grants must come through government entities.  To learn more click here to be directed.

That’s Nice: How do these programs affect my payment?

I am so happy you asked!  In fact, thank you for staying with me to this point.

Most of my borrowers discover they will be paying more per month on their mortgage payment using a DPA program than if they had the capacity to fund their own down payment.  It’s important to be educated to know your options and work with a Lender who takes your best interest as their own.  Many lenders shy away from discussing the differences for fear of losing you as a client and potentially their referral partners. 

Let’s review using a FHA loan with the Home in Five and Home Plus programs compared to using your own funds or a gift as a down payment source.  The purchase price is $275,000 and the down payment requirement is 3.5% or $9,625.  This scenario is based on a 660 FICO without the special incentive.  I did not use the special incentive in this case because not everyone will qualify for that advantage.  If you do, you will simply get an additional 1% in assistance.  See below:

There’s no free lunch

Most lenders will tell you to refinance this loan later.  If you’re buying a home getting instant equity at the purchase, then this is a good strategy because ultimately you will build value much faster.  But what if you don’t get that instant equity?  You are stuck paying that additional $166 for the next 36 months.  That adds up over time, $8,080 in interest with less money going towards principle.  Go back to the beginning when I described your grant proceeds on $275,000, the total was $7,961.25.  Essentially, you are still paying for your down payment over the course of 3 years.  It’s a borrowed grant.

Here is a look at a conventional loan scenario taking into consideration the HFA Preferred mortgage insurance rates and the Homeready program.  This is the same purchase price at 3% down.

In this scenario, you’re paying $7,990 in additional interest over 3 years and less towards your principle during that time.

Starting out with Negative Equity

I had a client recently hit a Homerun out of the park using a DPA.  Their home apprised $40,000 higher than the contract purchase price.  Even though they have a forgivable silent second mortgage, we are going to refinance them this summer and lower their payment.  They will have to pay back the grant, but it comes out of the equity they already have.  They will be saving substantially each month and over the life of their loan.

However, for many borrowers using a DPA, they may not get that kind of sweet.  It’s rare for that kind of value to come in and it takes a great Realtor to make something like that happen.  You need to be aware that you will start out in a negative equity position when you use this program because of the silent second lien. 

If you refinance or sell your home, you need to pay off your home for at least to total of your mortgage liens.  For example, take the same $275,000 house using FHA.  The total lien amount will be $277,980 when you purchased the home at $275,000.  For conventional, the total lien amount will be $274,752, which is a little better, but nearly 100% loan-to-value (LTV).  My point to this is your appreciating value of your home will take longer to realize if you want to consider a refinance or selling your home for the shorter future.  You must have some equity for a refinance to make sense.

Down Payment Alternatives

The down payment on a home is not limited to have a large saving account or waiting years to buy a home with 20% down.  In fact, many borrowers have been savings all along and don’t realize they have the resources available to purchase a home.

Your 401k through your employer is a solution.  Most 401k plans allow you to borrow against your plan up to 50% of the vested balance for any purpose.  The money is not taxed and is paid back through payroll deductions.  Some plans even allow the interest you pay on the loan to go back into your 401k or the payments are made pre-tax.  You will need to check with you plan provider.

An IRA can be leveraged if you are a First-Time Homebuyer purchasing your primary residence.  Up to $10,000 can be withdrawn without the penalty if you are withdrawing before you turn 59 ½.  You will still pay taxes on the $10,000 distribution (if a traditional IRA or Roth IRA when the $10,000 exceeds your initial contribution).

Immediate family can also gift you the down payment to purchase a home.  Many times borrowers let their family know their plans and it comes up that they can help contribute to their future.

I want to use the DPA

There is absolutely nothing wrong with using the DPA programs described here.  In fact, if this is the only option for purchasing your home, it is a good solution because ultimately, you still build wealth and fix your overall monthly expenses for the future.  It is just important to understand the differences and how it can affect your overall monthly payment IF you have the capacity to qualify for a home loan without using these programs.  We have not turned anyone away wanting to use these programs and will always make sure to do our best giving borrowers access to homeownership.

Conclusion

If you made it this far, I thank you whole-heartedly.  I have these conversations daily and wanted to make a post about DPA’s for a while to help educate and explain the basics.  The decision to buy a home is not something to take lightly and should be treated with attention to detail.  Fortunately, working with our team, we will manage the details for you so all you need to think about it which home you like best.  Happy House Hunting!

Chris Gonzalez

480-442-4494

Contact

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Mortgage Planning – 2-1 Buy Down can save for the future

Many new products and programs have come down into our product offerings at All Western Mortgage.  With some of the new products we now offer, we can approach our clients with better solutions for their home mortgage when they are buying a home.  In this blog, I go over a unique product called a 2-1 Buy Down.

2-1 Buy Down for FHA and Conventional Purchase Loans

The name of this product sounds like one of those loans from pre-2008 but is far from that family of products.  A 2-1 Buy Down allows a borrower to lock an interest rate 2% below the Note rate for the first year, then the rate increases by 1% the second year.  Once years one and two are complete, the interest rate becomes the true Note rate that was locked.  This is a 30 year “fixed” rate loan.  See below for a quick example:

Initial Note rate locked 5.875%

1st year interest rate 3.875%

2nd year interest rate 4.875%

 

Sample Scenario Conventional Loan scenario

Purchase Price: $350,000

Loan Amount: $332,500 (5% down payment)

Principle & Interest Payments:

$1,563.54 @ 3.875%

$1,759.62 @ 4.875%

$1,966.86 @ 5.878%

Summary: What You can do

The savings on the payment between year one and year three is nearly $400 a month.  Then it comes down to $200 a month.  A borrower must qualify on the actual Note rate, which in this example is 5.875%.  But getting away with a lower monthly payment is not why someone will use this product.  In fact, if this is your motive, I would not recommend this.  The advantage of this product allows a borrower to pay that “savings” toward reducing the principle of the loan or money borrowed.  Come year three, the borrower will want to refinance into a new mortgage to eliminate the mortgage insurance.  Between the equity appreciation and reduced principle on the loan, they will eliminate mortgage insurance on the new appraised value.

See the example of the equity gained and built:

$400-savings year one x 12 months = $4,800 additional principle reduction year one

$200-savings year two x 12 months = $2,400 additional principle reduction year two

 

Total additional Principle Reduction first 2 years: $7,200

Estimated Equity Appreciation by year three at 3% – 4% appreciation: $30k – $40k

Total principle reduction from P&I payments first 2 years: $11,200

Down Payment when purchased $17,500

Grand total: $65k – 75k Equity built, earned, & paid

Why this is helpful

Remember you must have 20% equity to refinance without paying any kind of mortgage insurance on a conventional loan.  With the original purchase price at $350,000, a 20% down payment would mean $70,000.  In 2 years, using a 2-1 Buy Down, you can leverage the lower initial rate to make your regular mortgage payment, applying funds to reduce the principle owned, and refinance into a lower payment by eliminating the mortgage insurance on the loan.  If this were FHA, the same idea applies.  The Note rate may be higher than today’s rates but remember we cannot predict the future and it’s possible the note rate is the same, lower, or higher than the market down the road.

Conclusion

With interest rates on the rise, I believe consumers should look at products that give them better overall value.  You can plan your financial future a little easier with something like this and prepare your mortgage payment with more clarity with a product like the 2-1 Buy Down.  Request a customized review for your purchase plans before committing to this program.

 

-Chris

 

Follow this link for your FREE Homebot Report!

Chris Gonzalez

480-442-4494

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Part 1 of 2 – Intro to Renovation Loans

Still searching for a home?  Try this instead

Buy any home and renovate it before you move in

In a Seller’s market, inventory of homes for sale is low with the demand for housing high.  Buyers often find themselves taking a long time to find their perfect home and most of the time, settle on a place due to convenience.  I firmly believe that in our modern world, you shouldn’t need to “settle” for anything.  Renovation loans can help you create the perfect home you want.

There are two main types of renovation loans.  The Homestyle renovation loan is a conventional product while the 203k renovation loan is the FHA product.  Both are very similar in what you can and cannot include.

At the basic level, you can do anything from a facelift or façade rehab to adding square footage or even a garage.  Remodel a kitchen, bathroom, living room, flooring, paint, windows, you name it, it can get done.  Adding a pool and/or an outdoor BBQ can only be done with the conventional product.  Provided you can qualify for the loan, you can use your imagination for your project.  Check out a before and after of this bathroom.

Photo Courtesy of NXS Remodeling

What is the down payment? 

You might be surprised to find out the minimum down payment requirement is no different that a typical FHA or conventional loan.  You’ll need 3.5% of the total cost of the home plus the project on FHA and 5% for conventional.  See the example below: 

Conventional Loan Homestyle Renovation 

Purchase Price: $300,000

Renovation Budget: $50,000

Total cost: $350,000 X 5%

Down Payment needed: $17,500 

How do you qualify for the loan?

Qualifying for the renovation program is no different than qualifying for a traditional loan.  How you shop for a home may differ because you cannot max out your budget on the purchase of the home.  But remember, in a Seller’s market, you now open more possibilities with homes if you know you intend to put your own personal touches into the home after the sale.  More on this concept in another Blog Post.

What’s the catch?

There are a couple requirements you must consider.  Virtually any home can qualify for FHA or Conventional financing through this program.  Missing electrical, old plumbing, holes in walls, crumbling stucco?  YES, it can be done with this program.  But, there is no “self-help” allowed which means you will need a Contractor who is licensed, bonded, & insured.  They can be either a General Contractor or Sub-Contractor, depending on the scope of work.

It’s very important to speak with a Loan Officer prior to committing to this loan program.  There are many moving pieces and the lender, Realtor, and Contractor should be on the same page.  Don’t worry, that’s our job!  But it helps to have these professions lined up prior to making an offer.

How do I get started?

This program is not just limited to purchases.  You can refinance your existing home using this program if you are tight on equity for a HELOC or if you are in the middle of a gut job and need to fix your place ASAP.  This introduction to a renovation loan might be your solution for creating the perfect home vs settling because you had no choice.  Give us a call today for a free review to see if this is something for you.

Contact

Chris Gonzalez
(480) 442-4494
info@azmortgageprofessional.com
www.azmortgageprofessional.com

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