Private Mortgage Insurance (PMI)
If you want to buy a house with a down payment of less than 20% of the price, you will probably have to obtain private mortgage insurance (PMI) with your lender. This protects your lender from any unexpected situations that may occur on your loan, so he can take the risk to grant you a loan with lower down payment. PMI amounts can vary depending on the size of the down payment but are usually about one half of one percent of the loan according too the Mortgage Bankers Association of America. Mortgage insurance premiums are not tax deductible. For example, the house you want to buy costs $100,000. Your down payment is 10% or $10,000. To calculate the PMI amount the lender multiplies the rest of your loan (not counting the down payment), which makes 90% or $90,000, by half a percent or .005 and gets the result of $450 of annual down payment. Divide this sum by 12 and you will get monthly PMI payment of $37.50. Most homebuyers are obliged to pay PMI since 20% down payment is a lot of money in most cases, $20,000 for our situation. The other thing is that you will have to pay PMI until you cross that 20% mark on your principal. This process may take years especially if your mortgage loan is a longerterm one. Even though there is a law that requires mortgage lenders to tell their customers how many years and months is needed to pay off 20% of their loan and when they don’t need to pay PMI any more, you should still keep an eye on your principal payments. Notify your lender that it is tome to discontinue your PMI premiums when you reach 80% equity. However, if you are in so called highrisk borrowers group you may be obliged to pay PMI until you reach 50% equity or even during the whole life of the loan (for some FHA loans). Highrisk loans are for example the ones with reduced documentation that provides less proof on customer’s incomes and other information during the approval. Another reason to consider your loan the one with higher risk is spotty credit history or high debttoincome ratio. Nowadays there are many ways to avoid PMI even if you don’t put 20% of the loan right away. The first one is to pay more interest. The increase may vary from 0.75% to 1% depending on the down payment; if you accept it the lender can allow you not to make payments on your PMI. Your advantage is that mortgage interest is tax deductible. Another way is to apply for an “801010” loan. This program involves making a 10% down payment and than financing the rest of the home’s cost with two mortgages: the first one equals 80% and the second one equals 10% of the sale price. The second one has higher interest rate but since it is only applied to 10% of the loan sum of both payments on these two mortgages comes out lower than a payment on a one mortgage loan plus a PMI payment would be. Again, mortgage interest is tax deductible. For example, payment on a $100,000 house with an “801010” loan will be $17.45 cheaper than with a standard fixed mortgage with a PMI. For example, let’s see how it works for our $100,000 house. Under a standard fixed mortgage plan you make down payment of $10,000 and pay interest of 7.5% on the rest ($90,000). This makes total monthly payment of $660.45 ($629 interest payment plus $31.45 PMI payment). Under an “801010” plan you make two monthly payments; the first one will be $559 (7.5% interest on your $80,000 loan) and the second one will be $84 (9.5% interest on your $10,000 loan). This makes total of $643, which is $17.45 less than on the standard fixed rate loan.
