Private
Mortgage Insurance (PMI)
Another good
reason to put as much
down payment as possible
when purchasing a home is that you may be able
to avoid having to purchase private
mortgage
insurance (PMI), also known as "mortgage default
insurance", which can add hundreds of dollars
annually to your loan cost, and ironically
enough, may make it more difficult to qualify
for a mortgage. You will likely have to pay PMI
if your
down payment is less than 20 percent of
your home's purchase price. The reasoning behind
this is that the smaller your initial
down
payment, the less you have invested in your
property, and the more likely you are to default
on your loan. PMI protects the lender in case
this happens. PMI charges vary depending on the
size of the
down payment, but typically amount
to one-half of one percent of the loan. Even if
you can't afford a
down payment of 20 percent,
don't despair, because after the equity in your
property increases to 20 percent, you no longer
need this insurance, but this can take years on
a long-term
mortgage. Lenders are now required
by law to inform you when this threshold is
reached.
Also, be aware
that if you have a spotty credit history, or
fail to provide adequate proof of income or
other information during the approval process,
or are considered a high-risk borrower, you may
be required to pay PMI until you reach 50
percent equity. And some loans, like those
obtained through FHA, may require that you pay PMI throughout the life of your loan.
Example:
Let's say you want to purchase a house that
costs $200,000, but you can only afford to put
down 10%, or $20,000. The lender will multiply
the remaining 90%, or $180,000, by 0.005
percent, which results in an annual PMI of $900.
This amount is then divided into monthly
installments of $75.
How to avoid PMI
As the example
above demonstrates, avoiding the PMI can save
you lots of money. But if saving up enough money
to make a 20 percent
down payment is difficult,
there are ways that you can avoid this added
cost:
Pay more
interest: Some lenders may be willing to waive
the PMI if you agree to pay a higher interest on
your loan. Depending on the amount of the
down
payment, the rate increase can vary from .75 to
1 percent of the loan. One advantage with this
option is that the interest is tax deductible.
80-10-10
Financing: With this program, you are
essentially taking out two loans - an 80 percent
loan with your primary lender, and an additional
10 percent loan through a secondary
mortgage -
and making a cash
down payment equal to 10
percent of your home's purchase price. The
second mortgage will be at a higher interest
rate, and can be obtained from a variety of
sources, including the seller of the home or
even the same lender from whom you obtained the
80 percent loan. Best of all, the interest on
both loans are tax deductible.
Example:
Say you want to purchase a $200,000 home, and
you put down a 10 percent ($20,000)
down
payment. To cover the rest of the cost, you
obtain a $180,000 (90 percent of purchase
price), 30 year,
fixed rate mortgage with a 6.5
percent interest rate. Your monthly loan payment
will be $1,264.14, and PMI will cost an
additional, non-tax deductible $75 per month.
Your total monthly payment will be $1,339.14
If you do
80-10-10 financing on that same $200,000 house,
you put a 10 percent
down payment ($20,000). The
first
mortgage, equal to 80 percent of the sale
price, is $160,000 with an interest rate of 6.5
percent, which comes to $1,011.31 per month. The
second mortgage for $20,000 has a 10 percent
interest rate, and comes to $175.51 per month.
The total payment for these two loans is
$1186.82, saving you $152.32 a month in PMI
costs.
Removing PMI
If your initial
down payment was less than 20 percent, chances
are you were required to pay private mortgage
insurance (PMI) when you obtained your loan. PMI
protects the lender in case you default on your
loan. PMI charges vary depending on the size of
the down payment, but typically amount to
one-half of one percent of the loan.
Fortunately, once you reach 20 percent equity, PMI is no longer charged. PMI may also be
removed if there has been a recent appreciation
in real estate prices in your neighborhood.
Before signing
your
mortgage note, ask your lender written
disclosure detailing when PMI premiums can be
removed from the mortgage payments. Keep track
of your payments and your
mortgage balance, and
try not to be delinquent, as some services may
require 12 to 24 months of consecutive monthly
payments, and contact your mortgage service once
you reach 20 percent equity if they have not
contacted you. If you can afford it, try to make
extra payment toward your principal each month.
You may also be charged for a new appraisal if
your lender feels it is necessary.
Other ways to
remove PMI
As stated
before, PMI may also be removed if the market
value of your home has increased. This can
happen if there has been an appreciation in the
real estate value of homes in your neighborhood.
If you are unsure, you can contact a real estate
agent familiar with your area and have them
provide an analysis of the value of your home.
You can also take steps towards increasing the
value of your home by renovating it yourself.
Mortgage Glossary7
