Will you ever see your downpayment again?

by Tom Tousignant

in Blog, Home Buying, Refinancing, Wealth Building

I was thinking of titling this post, “Why I no longer hate PMI, and maybe you shouldn’t either”. I was doing some math the other day for a presentation I made at a local Chamber of Commerce luncheon and it struck me – much of a downpayment on a house will never be seen again by the owner! As an example, you put 20% down on a house purchase to avoid PMI (Private Mortgage Insurance). Some time later,¬†you have a need to access the wealth you chose to store in the house. There are only three ways to get to your equity:
  1. Open a Home Equity Line of Credit (HELOC)
  2. Refinance the mortgage to get cash out
  3. Sell the house.

With each option, a substantial amount of equity must be left behind. For the HELOC option, most of the money will be inaccessible, as the best HELOC’s today only allow the owner to get up to 90% of the current value of the house. Several banks limit HELOC’s to just 80% of the house value, so that leaves most or all of the equity trapped.

With a cash out refinance, rules changes with Fannie Mae, Freddie Mac and FHA guidelines limit the cash out amount to 85% of the appraised value of the house, leaving 15% of the wealth trapped inside the house.

To sell the house, you, as the seller, could expect to pay 5-7% in real estate commissions and anywhere from 1-3% in state taxes, and likely will not be able to sell the house for the full asking price. in the case of a sale, 6% to 10% could easily be lost in transaction costs, and the time to get access to the wealth could be as long as 6 months or more.

So, if you are thinking of putting 20% down on a home purchase to avoid PMI, maybe you need to run some numbers and scenarios and ask yourself, what if I need my money back? Might you be better off with a smaller downpayment, say 5-10%, even if you had to pay PMI? If you ever really needed the money and then find out the answer is, “you can’t have your money back”, due to declining property values, loan guideline changes, or a change in your ability to borrow, then suddenly PMI looks really cheap.

What if you only put 5% down, and then your home declines in value by 10% and you are now “upside down”? My first response is, “Who says your house declined in value?” If you aren’t selling your house, it doesn’t matter what someone says you house is worth, does it? You still have the same square footage, number of bedrooms, location, etc, so if you aren’t moving, the alleged value of your house is really meaningless to you.

Your home’s value does matter if you need to get some equity from it, and, forces beyond your control, namely property values and loan guideline changes, could make your equity inaccessible to you.

The lesson here – you might be better off with a larger monthly mortgage payment that includes PMI in order to have your money where you can access it rather that blindly following the advice of ‘do anything to avoid PMI’ and then finding out your wealth is gone.

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