It’s been a pretty lousy half-decade for income mobility in America. If you were one of the many who grew up with the American Dream glittering in your eye and started planning for the day you’d make your first million, you may be a tiny bit disheartened right now. But don’t worry — things are starting to stabilize, and there are options that have been closed for years that are starting to re-open for those who are trying to move up in the world.
One of those options, for people trying to purchase their own home, is called the 95-5-15 plan. Normally, it can be a bad idea for someone to put down less than 20% of a home’s value as the down payment, because it creates a legal obligation for the lender to purchase what’s called Private Mortgage Insurance (PMI). PMI insures the lender against you backing out on your debt — and because that’s a substantial risk (much more likely to come true than, say, a house fire,) PMI insurance premiums are expensive.
The 95-5-15 plan, however, allows you to put your capital to better use than tying it up in the equity of your home. It works off of the principal that, although PMI is expensive, interest rates are so low right now that you can still get good financing terms, even with PMI factored in.
Here’s how it works. You want to buy a home for say $300K. Instead of putting 20% down ($60K), you opt to put 5% down ($15K) and finance 95%. Then you take the $45K you didn’t put down (15%) and invest it. Over the course of a few years, you should have no problem earning an ROI far higher than what you are paying for the PMI.
And don’t forget – while you are earning a return on your investment, you are also paying down principal on your home. At the end of say, 5 years, this should leave you having to come up with far less money to buy out your PMI. So if you want to do a buyout at that point, you will eliminate your PMI, and have a significant portion of that 15% principal you saved during the purchase of the home.
Remember, though, this strategy only works while interest rates are low. As soon as rates climb back up a couple points, it may no longer be worthwhile to employ this strategy. So if you’ve got the financial capability, now is the time to take advantage of the 95-5-15 plan.
About the Author:
This is a guest blog post from Richard Simon, Co-Founder of Realty AZ Central. Realty AZ Central is a Phoenix Arizona based real estate marketplace offering a host of home buyer and seller resources including home selling tips, mortgage lender referrals, and a local real estate agent network.