Private Mortgage Insurance (PMI)
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Private Mortgage Insurance (PMI)
By:Martin Lukac
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. (Don't forget the homeowners
insurance) 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
took effect in the summer of 1999 requires 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.
You can find more Homeowners
Insurance Information here
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