Neuswanger: Mortgage down payment insurance a questionable investment (column)
Recently, a Denver mortgage lender has been running TV ads offering homebuyers an insurance policy to cover their down payment in the event their new home purchase drops in value. What are lacking in his rather overbearing 30-second commercials are details.
The concept of insuring that if your property value declines and you are faced with losing money on a sale that you will at least get your initial down payment back is an appealing concept to any homebuyer, but this offer comes with some strings attached, and my best advice is don’t bet such a policy will ever be worth much.
Let’s say you buy a home for $500,000 and put 25 percent down ($125,000). The maximum amount you can insure is 20 percent of the purchase price (or $100,000) and you would pay a one-time charge of $4,200. And here are a few highlights from the terms of this “insurance policy.”
First, you have a limited window of coverage, generally from years two to seven you own your home, to show a loss and make a claim. If you sell in year one or year eight or later and take a hit, you are out of luck.
You are also not covered for any improvements you invest in, such as a new roof or carpet and paint or the additional $25,000 you put down. In addition, eligibility for a claim is only in relation to the home price index for the state your home is in, not your neighborhood or what you end up selling the home for.
Let’s continue our example: In year four, you get a job transfer and must sell. Things in your neighborhood have just not been selling, and you have put off a few repairs, which lowers the value of your home, although the rest of the state has actually appreciated since you bought and the average home price index for your state actually went up 3 percent since you bought.
You sell for $475,000, or a 5 percent loss. Thinking you are covered by your “insurance” you paid for at closing, you feel OK about taking the hit and call the company to make a claim. Your claim will be denied because it’s not their fault your home and neighborhood didn’t keep up with the rest of the state.
Let’s say the state index declined 5 percent, meaning in a typical neighborhood your home would be worth $475,000 but your home declined 10 percent to $450,000. Again, it is not the insurer’s problem that you picked an area that got hit worse than the rest of the state. In this case, you would be able to make a claim, but only for $25,000 instead of the $50,000 you actually lost.
Like mom always told you, if it’s too good to be true, it probably is.
Chris Neuswanger is a mortgage loan originator with Macro Financial Group in Avon and may be reached at 970-748-0342. He welcomes mortgage-related questions from readers. His website and blog can be found at http://www.mtnmortgageguy.com.