Why NOW is the Time to Buy Real Estate

I’ve been considering the purchase of a new home for some time now, but have delayed my purchase in large part because I don’t have the full 20% down payment amount that is required in order to avoid incurring Private Mortgage Insurance (PMI) on my mortgage loan.  I’ve personally pre-qualified for a maximum home purchase price of $400K.  Assuming I put 10% down, my PMI payment would equate to approximately $300/month – that is a lot of money when you consider that you receive no personal benefit from PMI.  That being said, there are some changes taking place within the mortgage industry that may actually negate my justification for putting-off my real estate purchase, leading me to believe that NOW may actually be the right time to buy.

What is PMI?

For those not familiar with PMI, it is extra insurance (besides the necessary hazard insurance) that lenders require from homebuyers that obtain loans greater than 80% of their new home’s value; in other words, buyers with less than a 20% down payment. The benefit of PMI is that it allows borrowers to obtain a mortgage with a lower down payment because it protects the lender against any default on the loan.  With PMI, it is possible for you to buy a home with as little as a 3.5% to 5% down payment. This means that you can buy a home sooner without waiting years to accumulate a large down payment.

The detriment of PMI is that it can be costly to the borrower with the annual cost equating to approximately 1% the total value of your loan.  This 1% is an annual figure and is divided into monthly payments and added on to your monthly mortgage payment.  Thus, even though you may have a 5% Annual Percentage Rate (APR) on your mortgage loan, in reality you will be paying close to 6% APR with PMI for as long as that PMI remains on your loan.

The Homeowner’s Protection Act (HPA) of 1998 requires lenders to provide certain disclosures concerning PMI for loans secured by the consumer’s primary residence. Under HPA, mortgage lenders must automatically cancel PMI coverage on most loans, once you pay down your mortgage to 78% of the value if you are current on your loan.

Increasing Mortgage Loan Interest Rates

The chart to the right illustrates the movement of interest rates across the last three years.  As you can see, interest rates hit a low in 2010 at around 4.33%.  Since then, interest rates have jumped back up to around 5%.  According to BankRate.com, nearly twice as many people believe that interest rates will continue increasing than believe interest rates will begin to decrease again.  I’m with the majority in believing that interest rates will continue increasing in the years to come, personally estimating that interest rates will hit around 6% within the next 1- to 2-years.

Why NOW is the Time to Buy Real Estate

As stated, I have personally held off on the purchase of a new home because of my desire to save up the full 20% down payment amount that is required in order avoid incurring PMI on the resulting mortgage loan.  Assuming a mortgage loan amount of $360K ($400K purchase price less the 10% down payment I have at present), my PMI payment would equate to approximately $300/month – that is a lot of money when one considers that PMI provides no personal benefit.  Thus, my plan has been to wait for another 1- to 1.5-years or so until I have saved up the equivalent 20% down payment so that I can avoid that PMI.  Sounds like a solid plan, right?  I thought so – that is, until I started considering the implications of the increasing mortgage loan interest rates detailed in the previous section.

Most feel that mortgage loan interest rates are going to increase in the near future, rather than decrease.  I personally believe that interest rates will increase by around 1% over the next 1- to 2-years.  Thus, waiting another 1- to 1.5-years to buy a home will substitute the 5% APR at which I’m presently qualified for a future rate of 6% APR.  The question then becomes, is it more beneficial to buy now at a 5% APR and incur PMI equivalent of 1% of the loan amount, or is it more beneficial to buy later at a 6% or greater APR to avoid the PMI?  In my opinion, the prudent move would be to buy now.  Whereas PMI drops off your mortgage once your loan is paid down to 78% the value of your home, an escalated interest rate stays with you throughout the life of the loan.  Thus, if I purchase now at a 5% APR, granted I’ll incur PMI, but only for a period of 5-10 years.  If I wait to purchase, I’ll have a 6% APR for the entire term of the loan.

So how do I substantiate this reasoning?  Let’s look at the numbers:

Assuming a $400K loan at 5% APR, including 1% PMI for 8-years (until I pay down to 78% the home value), the total amount I will repay on the loan over a 30-year term would be approximately $805,023, consisting of $773,023 in principal and finance charges, as well as $32,000 in PMI.  Now we’ll look at the numbers associated with the alternate scenario:

Assuming a $400K loan at 6% APR with no PMI, the total amount I will repay on the loan over a 30-year term would be approximately $863,353.  Thus by purchasing now, I would stand to SAVE approximately $58,330 over the 30-year term – no matter how you look at it, that is a lot of money!

So if you’re thinking about buying a home, don’t holdout – it could cost you!  Start looking around if you haven’t already begun to do so.  Don’t have an agent and/or lender yet?  Well if you live in Southern California, give Nathan Crowley of Team Metro Real Estate a call at (858) 882-8845 or email nathan@team-metro.com.  Nathan is a FANTASTIC real estate agent and will help simplify the real estate purchasing process for you, or for anyone else you know that is considering a real estate transaction.  I personally bought and sold my first home using Team Metro and couldn’t have been happier with both the results of the transactions and the personal service I received.  Nathan prides himself on his client-centric approach to real estate as he strives to build personal, long-lasting relationships with all clients.  In addition to providing his real estate clients with a superior quality of service and an unsurpassed level of personal attention, Nathan will offer clients the financial peace of mind that so few have the privilege to enjoy during the home-buying and/or home-selling process.  For those clients that feel they might benefit from meeting with a PFC to help better understand the financial effects of buying/selling a home, Nathan will cover the cost of a 10-hour Prudent Penny Personal Finance Coaching Package!  To read more about what this package entails, read my blog entitled Our Strategic Partnership with Nathan Crowley of Team Metro Real Estate.

1 Comment for this entry

• 

  Nathan

  February 28th, 2011 on 12:10 PM

  exciting stuff Derek; again a great topic to discuss with your readers.