When is it OK to purchase a house without making a 20 percent down payment?
When you're willing to pay private mortgage insurance (PMI). And that's not something you want to do.
PMI costs about $75 per month per $100,000 borrowed. So, if you borrow $200,000 on a home, and you don't put down at least 20 percent on the transaction, you'll have to pay out an extra $150 per month as part of your mortgage payment.
Private mortgage insurance does nothing for you except pay your mortgage company in the event they have to foreclose on you and they lose money. PMI is foreclosure insurance that protects the lender, and you get to pay for it if you don't make a 20 percent down payment. In the scenario I mentioned before, that would be an additional $1,800 per year on a $200,000 loan. In a sense, that's an extra 0.9 percent on your interest rate. That's what it feels like.
So, you can see PMI is not a positive thing. Often, a first-time homebuyer will purchase a house with 10 percent down then pay the other 10 percent as quickly as possible in order to get rid of the PMI. Stay away from it, Hannah. It's nasty stuff.
Loving your friend enough for the truth
I have a close friend whose 17-year-old daughter is going to college to become a high-school band director. Her daughter wants to take out student loans to attend an expensive private school, and tuition alone over four years will cost $100,000. I feel this is a really bad idea, but I don't know how to talk to her about this.
I'm sure your friend and her family are nice people. But what we've got here is a little teenage girl who has her heart set on something, and no one has told her no in a while. You're getting ready to help introduce a new word into her vocabulary because what you've described to me is stupid.
Listen, I love high school band directors. It just doesn't make sense to spend more than $100,000 on a degree to become one. Most of them make about $30,000 per year, so the return on investment for this kind of thing is terrible. It doesn't matter if you're a band director, English teacher or a doughnut shop owner, you need to figure out what you're going to make versus what you spend to get there.
Make sure you talk to your friend directly, not her daughter. If you do that, you'll end up branded as mom's mean friend. Use your relationship and history together to help her see this is a train wreck waiting to happen. My suggestion would be for her daughter to live at home, work, and attend a community college for a couple of years. Then, when she transfers to a four-year school, make sure it's a state institution and she keeps working.
The trick is to kindly and gently maintain enough influence to guide these two weak people away from a horrible decision. At the same time, you've got to be strong enough to call mom out for not stepping up and providing proper guidance. Mommies who don't try to stop their babies from doing things this dumb are known as bad mommies. People who spend $100,000 to $150,000 to make the kind of money that's waiting on her daughter are either young and inexperienced, or they're what are known as fools.
I'm sure you'll find a nice way to say it, but basically your friend needs to grow a backbone and tell her daughter no.
Dave Ramsey is America's most trusted voice on money and business. He's authored four New York Times best-selling books: "Financial Peace," "More Than Enough," "The Total Money Makeover" and "EntreLeadership." The "Dave Ramsey Show" is heard by more than 5 million listeners each week on more than 500 radio stations. Follow Dave on Twitter at @DaveRamsey and on the Web at daveramsey.com.