| 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 one-half 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 $10,000
on a $100,000 house. The lender multiplies the
90 percent loan, or $90,000, 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 $20,000 on a $100,000 home.
Homebuyers must maintain the PMI premiums until
they cross that one-fifth-of-principal threshold,
a process that can take years in longer-term 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 so-called high-risk 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 debt-to-income
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 "80-10-10" 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 $100,000
home under the "80-10-10" 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 "80-10-10"
plan, the 10 percent down payment on a $100,000
house is $10,000. The first mortgage is $80,000
at 7.50 percent, which comes to a monthly payment
of $559. The second mortgage for $10,000 has a
9.50 percent interest rate, making a monthly payment
of $84. Total monthly payments of the two loans:
$643.
With a $10,000 down payment, one mortgage of
$90,000 at 7.50 percent has a monthly payment
of $629, plus PMI of $31.45, making a total payment
of $660.45.
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