What is the earnest money deposit in a real estate transaction?

First-time homebuyers know that they’ll need a down payment if they hope to get a loan.

What they often don’t know is that they will also need cash to use as what is known as an “earnest money deposit” to submit with the offer to purchase when they find the home they want.

This deposit takes its name from its purpose: It shows the sellers that you are earnest about following through with the transaction to purchase the home – you are, in essence, “putting some skin in the game.”

Although the amount of the deposit isn’t set by law, it varies according to region and the real estate customs within that region.

Something called “liquidated damages” typically determines how much a savvy listing agent will counsel her clients to demand.

Liquidated Damages

Buried within most pre-printed real estate purchase agreements is a clause known as “Liquidated Damages.” This concept is defined well by Bob Hunt at RealtyTimes:

“A liquidated damages clause sets in advance – at the time of contract formation – what the monetary value of damages shall be in the event of contract breach by one of the parties.”

In other words, should the buyer fail to hold up her end of the bargain, the seller agrees not to sue but to keep whatever amount of money the parties have determined will cover damages.

The amount of liquidated damages is stated as a percentage. In California for instance, that amount in most cases is 3 percent of the sales price of the home.

So, what do liquidated damages have to do with your earnest money deposit? If you default on the purchase of the home, this deposit may be forfeited as liquidated damages.

The liquidated damages clause must be initialed by both parties to be valid and the release of the money must be agreed to as well. Then, there is the issue of trying to prove that you suffered damages.

How Much?

The amount of earnest money you’ll need to deposit will vary by region and also by homeowner dictates. One percent of the purchase price is standard in Northern California but the buyer is typically asked to increase the deposit after the removal of contingencies.

As mentioned earlier, smart listing agents will counsel their clients to ask for an increase that will make the deposit equal to the maximum amount of liquidated damages.

Like many aspects of the residential purchase agreement, the amount of earnest money to deposit is negotiable so – whether you are the buyer or the seller — ensure that you’ve hired a knowledgeable real estate agent that can counsel you wisely.

Home-Buying Tips for Veterans

Veterans Day this year is November 11 (observed on the 12th) but to us, November is Veterans Month. And what better time to remind those who have served our country and their surviving spouses that the best mortgage on the market just may be the one that was created for them?

When comparing mortgages, especially when you’re short on cash, it just doesn’t get better than a loan that requires no down payment, the possibility of not having to pay closing costs and no private mortgage insurance requirement.

VA loan requirements are different from other loans, which many veterans find confusing. Because they don’t understand these requirements, even some real estate agents will try to steer military clients to other products.

Let’s take a look at three of the most frequently asked questions we receive about the VA loan.

What credit score does the VA require?

Since the VA doesn’t grant loans (it guarantees the repayment of a portion of the loan) it has no minimum credit score requirement. They leave that up to the lenders.

The good news is that because of the government guarantee, lenders tend to be more lenient with their credit score requirements.

Aim for a credit score of no lower than 620 and, remember, you would need a 740 or higher for most conventional loans.

Lenders also look at your ability to repay the loan. This includes an confirmation of:

  • Stable income
  • A debt to income ratio of no more than 41 percent. Even if yours exceeds this percentage, you may still qualify if you can prove “compensating factors.”

How much will I need for closing costs for a VA loan?

The amount the borrower will pay for a VA-backed loan’s closing costs varies by lender, the type of home, where you are buying and other factors, but plan on paying between 1 percent and 5 percent of the loan amount.

By the way, the VA limits the borrower’s closing costs to a specific list of items.

Although the VA doesn’t allow borrowers to finance the closing costs of their mortgage, they are quite flexible on who can pay them on behalf of the veteran.

This means that the seller or anyone else can pay all or part of your closing costs, quite possibly allowing you to buy a home with no money out of your pocket.

Speak with your lender about the various ways of dealing with VA loan closing costs.

Do I have to live in the home that I purchase?

Yes, you do. In fact, the law requires the borrower to certify that the home will be owner-occupied as the primary residence. You’ll have 60 days from closing to take occupancy, although extenuating circumstances may allow occupancy to be extended to 12 months.

By the way, for service members on active duty, occupancy by a spouse or dependent child fulfills the occupancy requirement.

There are, of course, exceptions to this rule. A PCS may allow you to rent out the home. Or, the borrower can apply for  an Interest Rate Reduction Refinancing Loan, which only requires that you certify that you previously occupied the home.

Contact the Regional Loan Center with any questions about the occupancy requirement. You’ll find yours on the U.S. Department of Veterans Affairs website.

 The first step in the VA loan process is to obtain your Certificate of Eligibility and you can do that online or through your lender.

By serving our country, you earned this housing benefit. Take advantage of it.

 

Selling Mom and Dad’s Home

One of life’s most challenging aspects is watching our parents age. Then comes the day when you, and they, realize they’ve lost their physical independence.

Whether they are downsizing into a smaller, less maintenance-intensive home or are moving in with you or to a care home, giving up a long-loved home is wrenching.

Thankfully, they have you and you have us and we have tips to help your parent or parents — an you — through this tough time.

Get legal advice

You may be required to use the proceeds of the sale to pay for your parents’ care if they will be moving to an assisted living facility or long-term care facility and will require Medicaid to pay for their care.

Speak with your attorney early in the process to learn about the complex aspects of selling an elderly parent’s home.

Line up some labor

Cleaning out a family home is a huge job so don’t try to tackle this alone. If you have siblings, enlist their help. In fact, insist on it.

Not only will you need their muscle but having family around may help ease your parents’ transition as well.

Otherwise, hire some help. Visit the neighbors to let them know what’s happening and ask for a referral to local manual laborers. Who knows? They may volunteer to help.

Hire a real estate agent

It may seem that it’s too early in the process to hire a listing agent, but we disagree, and here’s why.

Your agent should see the home before you start moving things out of it. Advice on what to leave for staging purposes is invaluable.

Ask for tips on whether to paint, replace carpet and other updates that will make the home more attractive to potential buyers.

Your agent will also be able to refer you to an estate sale company (if needed to help get rid of belongings), cleaners, painters and more.

Hiring an agent early in the process also allows Mom and Dad to get to know the agent and feel more comfortable about the sale process.

Move first, then sell

Because it’s so important for the homeowner not to be present during buyer showings, most experienced real estate agents will counsel you to move your parents before putting the home on the market.

If they need the equity from the current home to move, however, come up with another solution. Perhaps they can stay with you or a sibling until the home sells.

It’s time to purge

Purging a lifetime of belongings (and memories) will be the most challenging aspect of downsizing for your parents. What to keep, what to get rid, of will be decisions not easily made.

“ … the problem isn’t denial, but rather, the extraordinary difficulty associated with giving up items that are so closely linked to their identities, their past and their memories,” claims Sarah J. Stevenson at APlaceforMom.com.

It’s not really the items, it’s the memories attached to them

One way to ease your parents’ reluctance is to promise them that you will photograph everything they decide to get rid of and place the photos in a lovely scrapbook that they can take with them to their new home.

Or, if they prefer, you can video their cherished-but-leaving items. This way, they’ll still be able to refresh those memories.

Still, unless the parent is suffering from dementia, it’s important to allow him or her to take the lead in the purge. Yes, it will be slow-going, but it’s important that, in the future, they don’t look back and feel they were railroaded into getting rid of certain items.

Gather family members together to go through your parents’ purge pile. As one elderly woman in an online forum stated, “It is SO much better to know cherished family things will continue on.”

Have conversations with Mom about these items and the stories behind them. This helps ease her anxiety and lets her know that the memories associated with the items will live on.

Should I Sell my Home and buy Another Now or Wait? 

We don’t need a crystal ball to tell us when to take the first step in determining if this is a good time to sell a home and buy another.

While market conditions should play a role in your decision, the first step starts with you, and the state of your finances.

Your Personal Finances

How’s your credit? Lenders have tightened their FICO requirements. Even FHA has raised the lower end of their acceptable FICO range.

How long have you been in your current job? Lenders want to see at least two years with the same employer, or in the same line of work and no decrease in income.

Next, do you have the cash to put down on a home? In this strong seller’s market you may be able to use the equity from your current home to fulfill the down payment requirement on your new home.

You’ll need at least 20 percent of the price of the home if you go with a conventional loan. If you obtain an FHA-backed loan, the down payment requirement has a lot to do with your FICO score.

That said, lending has become so tight that sometimes a stellar FICO score can’t make up for lower income, a spotty job record and even a huge down payment, according to news from the Wall Street Journal.

Don’t forget closing costs. These are the fees you’ll need to pay when you close on the purchase of the home. They vary, but a rule of thumb is to have 2 to 5 percent of the purchase price in cash reserves.

Timing the Market

If you’re trying to time the market so that you sell at the top, good luck. Nobody knows when a particular market will top out, until it starts its downward move.

But, there are signs in the economy you might want to watch, according to some experts, that the real estate market is changing. These signs include:

Unemployment

Housing market prognosticators keep a close eye on unemployment numbers. It’s only natural that people worry more when their jobs aren’t secure. This anxiety tends to make them hold off on spending money.

Consumer confidence typically lags right along with low employment numbers. When the jobs situation improves, so does the confidence of Americans and money begins flowing again.

Right now, unemployment is quite low. But these numbers only help us figure out part of the story.

The Housing Inventory

A “shrinking inventory” is a real estate term that describes a market in which the number of homes for sale decreases. Think of it as supply and demand.

When there are fewer homes on the market, prices tend to rise, which is a good sign if you plan on selling your home.

New Housing Starts

Homebuilders sit out tight economies. When people are back to work and spending money again builders begin new developments. While national new housing starts are important, keep an eye on the state and local trends.

While it’s wise to monitor economic indicators to help time your home sale to coincide with the top of the market, there’s also a danger in that. The only sure-fire way to know that we’ve hit the price peak of the market is when prices start falling. By then, it’s too late.

Real estate markets move in cycles and can take excruciatingly long to change, or they can transform almost overnight. The ideal time to sell a home is when prices are high and there is lots of competition from homebuyers.

That time is now.

What are you looking for in a home?

When I bought my first home my priorities included a big backyard and the home had to be single-story. Yes, I was young, and obviously not too bright. I ended up with the backyard of my dreams in a single-story home that otherwise didn’t fit my lifestyle or tastes.

What’s your hot button?

Yes, it seems to be a simple question, but it turns out that the answer is complex.

Impulse buying is real. Retailers know this and take advantage of our tendency by using in-store cues to direct us to impulse buys. From magazines to peruse (and hopefully throw into your cart) as you wait in line to that snazzy lemon squeezer right next to the lemons in the produce department, impulse buys are everywhere.

The same holds true when shopping for a home. In the hands of a savvy real estate agent, a home for sale is presented in the best light possible. Trendy paint colors, strategic lighting and the presentation of a certain lifestyle are sure to appeal to many buyers. If the home appears to be in move-in condition, it’s even more appealing.

Avoid these strategic distractions by being absolutely clear on what you want and need in a home. This requires making a list.

But, this isn’t necessarily a shopping list, which is actually a list of needs. Think of it as more of a menu – a list of both wants and needs, with the latter prioritized.

Create your menu

This list should contain those features of a home and a neighborhood that are most important to you and your lifestyle.

Let’s start with the location. To do that, you’ll need to understand what type of structure you want to buy You typically won’t find mobile homes in the downtown area or condos in suburban neighborhoods. So, make this decision first:

  • Condo
  • Single-family house
  • Duplex
  • Townhouse
  • Mobile home

Now you’ll need to construct that menu. Remember, your needs take priority, but there’s also room on the menu for “desert,” those things that would be nice to have, if possible. Here are some ideas to get you started:

  • Should the home be one story or are multiple floors ok?
  • Square footage needed
  • Number of bedrooms and bathrooms required
  • Work from home? Put a home office on the menu
  • Preferred yard size
  • Do you need a garage? One, two or three-car?
  • Additional amenities, such as a pool (on site or nearby?)
  • Commute time
  • Proximity to public transportation, schools, parks, etc.

Now, edit the list, placing priorities at the top. These are items that you absolutely cannot do without. For instance, earlier I mentioned that my priority was a big backyard. I got it, but I also got a lousy floor plan because I hadn’t taken the time to figure out its importance to me.

What’s important to other members of the family? You’ll all need to agree on which of their dream list items they’ll be willing to compromise on, if the need arises. And, it most likely will.

What are you looking for in a home? Take the time to figure it out, in detail, stick to the list, and you won’t regret purchasing your new home.

Everything you need to know about the down payment

Unless you have a big stash of cash, you’ll need to borrow money to buy a home. Oh, you’ll still need some cash (for the down payment and closing costs), so don’t stop socking it away just yet.

In fact, one of the things that confuses our clients most is the down payment they’ll pay when they get a home loan. So, today we’ll share some of the questions we most frequently field.

Why do I have to make a down payment?

Not all home loans (also known as “mortgages”) require a down payment, but most do. There are several reasons for the requirement. Primary among them is that the money helps protect the lender in case you default on the loan.

Secondary to that is the fact that lenders understand that borrowers with “skin in the game” are more apt to do whatever it takes to hang on to the home and not allow the loan to go into foreclosure.

Is the down payment the same as the earnest money I give the seller?

No. The earnest money’s purpose is to show the seller that you are earnest about buying the home. The amount varies and it is typically held in a broker’s trust account or in escrow until either the purchase is finalized or you or the seller back out of the transaction.

When the purchase is finalized, the earnest money deposit is credited toward your down payment or, in some instances, closing costs.

The purchase contract contains what are known as “contingencies.” For instance, your purchase may be contingent upon you obtaining final loan approval. Should this not come to pass, you can walk away from the purchase with a full refund of your earnest money deposit.

If, on the other hand, you get cold feet and walk away from the deal, the seller may have the right to keep the deposit.

I’ve heard that some sellers help pay the down payment. Is that true?

No, it is not true. Sellers cannot help the buyer with the down payment. On the other hand, they are allowed to contribute toward the buyer’s closing costs.

You can, however, use gifted funds, as long as the money doesn’t come from someone directly involved in the transaction. The person who gifts you the funds must be able to document where the money came from.

If the gift funds are undocumented, you’ll need to have them in your bank account for at least 60 days before the lender will consider them “seasoned.” In fact, even your own down payment funds must either be sourced or seasoned, so if you need to move money around, do it as soon as possible.

Can I use money from my retirement account to pay the down payment?

Yes, you can, but we urge you to speak with your financial advisor or accountant before doing so. There may be penalties or tax ramifications that you should consider.

You’ll find information on borrowing money from your 401k at smartasset.com and moneycrashers.com. You’ll also find an article about why it isn’t a good idea to withdraw retirement funds for a down payment at kiplinger.com.

Again, we urge you to speak with a financial advisor before making the decision.

How much will I need to pay for a down payment?

How much you’ll be required to pay for a down payment depends on the loan product you’re using. The U.S. Department of Veterans Affairs and U.S. Department of Agriculture loan programs require no down payment but each has specific eligibility requirements.

Other loan programs, such as those offered through FHA and Fannie Mae and Freddie Mac offer low down payments and the range is generally tied to credit scores. With a conventional loan, you’ll typically be expected to pay 20 percent of the loan amount for the down payment.

But, consider voluntarily paying a larger down payment, if it’s within your budget. The more you pay, the smaller the loan amount will be and, thus, the smaller your monthly loan payment will be.

Make a down payment that nets you 20 percent equity in the home and you won’t be required to purchase private mortgage insurance, which adds a hefty premium fee to your monthly house payment.

When is the down payment due?

While you will need to show the lender proof of your funds for the down payment, the actual monies aren’t due until closing.

The lender will send you a form, called the “Loan Estimate.” While it breaks down all of the costs associated with the loan, pay special attention to the “Costs at Closing” section, specifically the second line under that heading, “Estimated Cash to Close.”

You’ll find a sample Loan Estimate online at consumerfinance.gov.

This amount reflects how much you’ll need to provide to your lender before the transaction is closed. It includes the down payment and closing costs and the lender typically requires the funds be in the form of a cashier’s check or wire transfer.

Please don’t hesitate to reach out to us if you have additional down payment questions or to clear up any confusion on other real estate-related topics. We’re happy to help.

Home inspections aren’t just for older homes

A few years ago, RealtorMag put out a list of the “Top 10 Most Common Home Inspection Problems.” They range from faulty wiring to roof problems to foundation flaws.

Whether caused by deferred maintenance or just the aging of the home, the older a home is, the more likely it is to have issues.

Most buyers of newly-built homes breathe a sigh of relief over their assumption that they’ll be escaping having to fork over large chunks of money for someone else’s problems. And, they typically decide to forego a home inspection.

Yes, new homes don’t have deferred maintenance. Yes, all the components in these homes are new. That doesn’t mean, however, that the home is without an entirely different set of problems.

And that Certificate of Occupancy issued by the local municipality only guarantees that the home is livable, not that everything is in working order.

New doesn’t equal perfect

Not everyone who works on new homes during the construction phase is a master craftsperson. Laborers and contractors have varying sets of skills and experience. While most are conscientious, others cut corners.

Additionally, most of the construction tasks, such as framing, plumbing, foundation and electrical, are subcontracted out – usually to the lowest bidder. Speed, not quality of work, is the most important consideration for the builder.

Errors and omissions in construction, while not overly common, do occur. Bruce E. Holmes, an engineer based in Florida, tells Bankrate.com that he looks for fit and finish problems, such as crooked walls, connections that aren’t tightened and reversed hot and cold water lines.

Municipal inspectors aren’t enough

Don’t assume that county inspectors will find all problems that may exist. Bankrate relates the story of a private inspector that went through a custom-built home during construction, but after the county inspector performed his inspection.

He found cracked floor joists, missing fireblocks and what he describes as “tons of stuff” wrong with the construction.

Reuben Salzman, with Structure Tech in the Minneapolis/Saint Paul area of Minnesota, wrote a five-part series, with photos, of problems he has found in newly constructed homes. It’s well worth a visit to his blog, if only to view the eye-opening photos.

Too late?

Because some problems require seasonally-unique conditions to become apparent, most builders offer their buyers a warranty. For example, water intrusion into a basement won’t be apparent until the first big rain.

Warranty terms vary, but most offer terms for different types of work. For instance, you may receive a one-year warranty for faulty labor and materials, two years for mechanical defects and ten for structural problems, according to Ilona Bray, legal editor for Nolo.com.

“The result is that the best parts of the warranty expire quickly — your carpeting, tiles, paint, and roofing, for example, may not be covered after the first year,” she said. Bray also suggests that you obtain an independent, professional home inspection before each warranty expiration date.

Since homeowner insurance typically doesn’t cover construction defects, get to know the warranty. Consult with your attorney, if you must, but ensure that you understand all aspects of it.

Whether you have a home inspection during construction (do so before the drywall goes up) or upon completion, the peace of mind it offers is worth the price.

Do Open Houses Work?

“In my experience, there is no correlation between houses we hold open a lot and houses we do not hold open at all and how fast or at what prices they ultimately sell for,” claims an unnamed real estate broker at zillow.com.

Then, there is real estate “scientist” Tim Ellis’ analysis of a study performed by a large real estate conglomerate. In San Francisco, he claims, “holding an open house is so expected there that homes that don’t hold an open house are a full seven percentage points less likely to sell than those that do.”

So, which is it? Do open houses help sell homes or are they a waste of time? Let’s take a look at both sides of the question.

Opposing Goals

Home sellers and their listing agents often hold opposing views on whether or not to hold an open house. The homeowner believes that holding the home open to the public exposes it to a broader pool of potential buyers.

The real estate agent, on the other hand, will typically hold an open house not only to lure in potential buyers but to attract more clients as well. In fact, skeptics of open houses will say that the real purpose of the guest register by the front door is part of the agent’s attempt to pick up new clients.

Then, there are others who claim that busy agents with lots of clients generally feel that open houses are a waste of time.

The stats

A hunt for research into the effectiveness of the open house as a home sales tool highlights the lack of available information. The National Association of REALTORS® finds that 45 percent of buyers use the open house as an “information source,” but fails to mention the percentage of these folks who actually purchased the home.

The study that Ellis analyzed finds that geographic location has a lot to do with whether an open house will sell a home. As mentioned earlier, San Francisco homes that are held open are more likely to sell than those that don’t have an open house.

In Las Vegas, on the other hand, only 3 percent of homes are held open, so naturally, homes here are more likely to sell without an open house.

“Everywhere else, the picture gets a little more fuzzy. In the other eight markets we examined, there was virtually no difference in the percentage of homes that sold, whether they had an open house or not,” Ellis claims.

One additional finding is worth noting: Homes that are held open during the first week of the listing period are 13 percent more likely to sell than homes not held open at all.

Furthermore, the likelihood of a sale doubles if the agent skips the first week and holds an open house later during the listing period.

Overall, this particular study shows that an open house is a must if you live in San Francisco and it’s a waste of time for Las Vegas homeowners. What about everywhere else? “It likely doesn’t really matter. . .” says Ellis.

The reality

Just as some hair stylists cut hair better than others and some lawyers are brilliant in front of a judge while others fall apart at the thought of it, some real estate agents are better at holding open houses than others.

Therefore, whether an open house “works” or not depends not only on the agent’s skill set, but on geography, seasonality and a host of other conditions.

Overall, it is effective marketing that sells a home and the most potent weapon in your marketing arsenal is your real estate agent. Whether or not he or she lists open houses in the marketing plan should have less to do with the agent’s effectiveness than their overall marketing chops.

How to stage your home’s closets to make buyers swoon

Ah, to be a fly on the wall as potential buyers traipse through your home for sale. You could watch them peer into your cupboards and closets and peek into the drawers in the kitchens and bathrooms.

Don’t worry – most of them aren’t being snoopy; they are merely trying to figure out where they can store their “stuff” if they decide to buy the home.

If you are like a lot of Americans, your closets don’t represent your best foot forward. If shoes are spread across the floor and clothing randomly crammed in any available space, the chances are good that your closet looks smaller than it is.

The good news is that with a small amount of money and a couple of organizational hacks, the closets in your home will be screaming “Buy Me!” to every potential buyer who peers within them.

Start with the walls

Staging a closet involves changing your mind-set about it. Don’t consider it a place to hide junk, store items you no longer use or even it’s true purpose – to keep your clothing.

Instead, think of it as an additional room in your home, at least for staging purposes. This means, removing the clutter and organizing it.

It also means creating the illusion of spaciousness, regardless of how tiny the space is.

Paint color and sheen can go a long way in creating this illusion. The most common advice is to choose the whitest shade of white you can find and slap it on the closet’s walls and ceiling.

Many architects and professional designers claim that’s hogwash – that white actually makes a room seem smaller. And, really, when you think about it, isn’t it better to get color advice from a professional than from a freelance writer who specializes in crafts or personal finance?

More important than paint color is sheen. “Painting in a flat, matte or satin finishes [sic] will soak up light, while semi-gloss, high-gloss and lacquer finishes tend to reflect light, which make a darker room feel brighter and lighter,” Edith Gregson, partner in a Washington D.C. design firm, tells the Chicago Tribune’s Danielle Braff.

No doors on the closet? Debbie Zimmer, spokesperson for the Paint Quality Institute suggests painting the closet’s interior the same color as the room or, perhaps a lighter shade of the same color

Give the paint something to reflect

Closet lighting seems to be an afterthought for most home builders. Unless you own a luxury home with a super-sized walk-in closet, you most likely are greeted by a lone, bare bulb when you go to hang your clothes up after work.

You also know how frustrating it is to have to drag two pairs of pants into the light of day to determine which is black and which is Navy blue.

So, the next task in the closet makeover is to get more light in there so the paint can do its job.

Lighting solutions don’t necessarily require rewiring. Check out some of the LED lighting options at large home improvement stores or online at lighting retailers.

Add storage items

One rod with a shelf above it – that’s the layout of the typical American bedroom closet. Sure, some are blessed with larger closets, but even those typically contain the lone-rod-and-shelf setup.

Adding additional rods below the current rod is always an option, as is adding additional shelves.

Find shelving and other storage ideas online at Houzz, Remodelaholic and Apartment Therapy.

Declutter and organize

Removing overly large and bulky items from the closet is winning half the battle when it comes to making it appear larger. Winter coats, blankets and anything non-clothing related should be moved to the appropriate area within the home or, better yet, to a storage facility.

Then, pare down what’s left to only those items of clothing and accessories that you actually wear. The jeans you’re saving for that day when you finally lose enough weight to fit into them? Get them out of the closet.

Purchase enough hangers so that they all match. Whether you choose metal or plastic, the most effective way to appear organized is by having them all match. Then, group your clothing along the rod, hanging all pants together, all shirts and blouses in one spot and so on.

If you really want to go for the “I’m the greatest housekeeper” award, follow this grouping by sorting everything in each category by color.

Finally, get the shoes off the floor by storing them in a rack or shoe bag.

A well-lit and organized closet not only offers the buyer the perception of additional storage space but gives him or her the impression that the entire home has been equally as impeccably maintained.

 

Busting the 3 biggest private mortgage insurance myths

One of the most frustrating issues we’ve dealt with over the past few years is the confusion over private mortgage insurance (PMI). Folks on the internet aren’t helping clear the confusion; instead, many are feeding it with misinformation.

The truth is, the average down payment on a mortgage is around 11 percent, according to the National Association of Realtors. That’s a whole lot of homebuyers who are required to purchase PMI. Because of that, we’ve decided to help smash the prevailing myths about this despised yet necessary program.

What is PMI?

Private mortgage insurance protects the lender if the buyer defaults on the loan and it is generally required of borrowers who pay less than 20 percent as a down payment.

There are exceptions to this that we’ll explore, below.

PMI typically costs between 0.5 percent to 1 percent of the loan amount, each year. “At 5 percent down, private mortgage insurance (PMI) costs $150 per month on a $250,000 home,” according to the U.S. Department of Veterans Affairs.

 

Myth Number 1: “Government-backed loans don’t require PMI”

This one is partially true. The VA loan doesn’t require PMI. However, the loan does require most borrowers to pay what is known as a “funding fee” which helps mitigate the burden on the taxpayer should the borrower default on the loan.

FHA does require that borrowers purchase mortgage insurance, although theirs is called MIP, for Mortgage Insurance Premium. There is both an upfront fee and a monthly premium payment required.

The former is typically the same for all borrowers (1.75% of the base loan amount), while the latter depends on a number of factors, including the loan amount, the term and the loan-to-value ratio. The premium amount changes annually, so check with your lender to learn about current MIP rates.

Myth Number 2: “You cancel PMI when you reach 20% loan-to-value”

This myth is partially true. If you have a conventional loan you can cancel the PMI premium when you reach the 20 percent equity level.

By law (Homeowners Protection Act of 1998), however, your lender must cancel the policy when you accumulate 22 percent of the home’s original purchase price in equity.

If, on the other hand, you have an FHA-backed loan, you can’t cancel the MIP unless you sell or refinance the loan.

Myth Number 3: “PMI is tax deductible”

This was true a year ago, but for 2018 tax returns, at least as of September 2018, this deduction is no longer available.

The ability to deduct PMI is one of those tax code provisions that expire every December 31st. Since its inception in 2007, Congress has renewed the deduction every year, sometimes at the last minute.

Hopefully, it will be again, but most tax specialists aren’t holding out hope. So, for now at least, “PMI is tax deductible” is a myth.

We aren’t mortgage professionals so we urge you to contact your lender or financial advisor if you have questions about private mortgage insurance.