March 6th, 2010
Private Mortgage Insurance PMI
If your down payment on a home is less than 20 percent of the appraised value or sale price you must obtain private mortgage insurance known as PMI with your lender. This will enable you to obtain a mortgage with a lower down payment because your lender is now protected against any default on the loan.
PMI charges vary depending on the size of the down payment and the loan but they typically amount to about onehalf of one percent of the loan according to the Mortgage Bankers Association of America. Mortgage insurance premiums are not tax deductible.
Example
Let’s say you put down 10 percent or 10000 on a 100000 house. The lender multiplies the 90 percent loan or 90000 by .005 percent. The result is an annual PMI of 450 which is divided into monthly payments of 37.50.
Most homebuyers need PMI because 20 percent of the sale price on a home is a lot of money; for instance that’s 20000 on a 100000 home. Homebuyers must maintain the PMI premiums until they cross that onefifthofprincipal threshold a process that can take years in longerterm mortgages.
Tip
Keep track of your payments on the principal of the mortgage. When you reach 80 percent equity notify the lender that it is time to discontinue the PMI premiums. A new law that takes effect in the summer of 1999 will require lenders to tell the buyer at closing how many years and months it will take for them to pay 20 percent of the principal to cancel PMI.
Note: The law does allow lenders to continue requiring PMI all the way down to 50 percent equity for socalled highrisk borrowers. Traditionally those loans that are considered riskier include reduced documentation loans in which customers provide less proof of income and other information during the approval process. Loans for people with spotty credit histories and higher debttoincome ratios also fall into this category. Additionally some FHA loans require payment of PMI throughout the entire life of the loan.
Ways to avoid PMI
In today’s market there are some new ways to avoid mortgage insurance even when you don’t have the standard 20 percent down payment.
Pay more interest: Some lenders will waive the mortgage insurance requirement if the buyer accepts a higher interest rate on the mortgage loan. The rate increases generally range from .75 percent to 1 percent depending on the down payment. The advantage is that mortgage interest is tax deductible.
Using an “801010″ loan: This program involves two loans and a 10 percent down payment. The 90 percent loan is financed with a first mortgage equal to 80 percent of the sale price and a second mortgage for the remaining 10 percent of the sale price. The second mortgage has a higher interest rate but since it applies to only 10 percent of the total loan the monthly payments on the two mortgages are still lower than paying one mortgage with mortgage insurance. Plus again there is the advantage of mortgage interest being tax deductible.
Example: If we compare the purchase of a 100000 home under the “801010″ plan with a standard fixed mortgage including PMI we find that the former is 17.45 cheaper each month.
Here’s how it works. Under the “801010″ plan the 10 percent down payment on a 100000 house is 10000. The first mortgage is 80000 at 7.50 percent which comes to a monthly payment of 559. The second mortgage for 10000 has a 9.50 percent interest rate making a monthly payment of 84. Total monthly payments of the two loans: 643.
With a 10000 down payment one mortgage of 90000 at 7.50 percent has a monthly payment of 629 plus PMI of 31.45 making a total payment of 660.45.
About the writer:
Martin Lukac represents 1 Loans USA a finance webcompany specializing in real estate/mortgage market. We specialize in daily updates rate predictions mortgage rates and more.
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