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The Who, What, Where, When, and Why of PMI
You’re ready to purchase your new home. You begin by calculating how much house you can afford. You have a comfortable monthly mortgage payment in mind. Your credit is decent. You’re all set to make your purchase until you check your savings account. Of course you’ve got money there, but the balance is nowhere close to the amount you need to cover 20% of the home’s cost…Houston, we have a problem!
The Dilemma
With rising home prices, more people are finding it difficult to save enough money for a typical down payment - 20% of the home’s cost. Lenders value sizeable down payments because they reduce the risk of lending. Borrowers are less likely to default if they own more of their home’s equity. They simply have more to lose than people who have invested little money to get their homes.
Everywhere there are ads claiming that you can buy a home with a low down payment or even at zero down. How is this possible?
Buyers have the option of either purchasing a much less expensive home or using more creative financing. Purchasing a less expensive home based on the smaller down payment may not be a realistic option. Borrowers that can only make a 10% down payment have half the buying power of those that can afford the full 20%. That could be the difference between a $300,000 loan and a $150,000 loan. With today’s housing market, the additional buying power is necessary for many people to buy homes.
Piggyback Solution
It’s time to get creative! If you have a down payment of at least 10%, you can take out a piggyback loan, also known as an 80/10/10. This financing structure involves a conventional mortgage and either a home equity loan or line of credit:
80% Conventional Mortgage Loan
+ 10% Home Equity Loan/Line of Credit
90% Total Cost Financed
90% Total Cost Financed
+ 10% Down Payment
100% Cost of Home
The home equity loan or line of credit is often referred to as a second mortgage. The interest rate of this loan will be much higher than the interest rate of the traditional mortgage loan. The second mortgage may be amortized over a 30 year time period to keep your monthly payments low. After 5, 10 or 15 years the loan may be called and you will have to pay the remaining balance in one balloon payment.
Be sure that the monthly payments and balloon payment are affordable. Remember that your home is used as collateral for both the traditional and second mortgage loans. If you default on either, you can lose your home. On the brighter side, you will probably be able to deduct the home equity loan/line of credit interest from your taxes.
But what if your down payment is not even 10%?
Private Mortgage Insurance – PMI
Lenders can also finance a mortgage loan with a small down payment through private mortgage insurance, PMI. PMI insures lenders on loans with down payments less than 20% of the home’s cost. PMI does not have limits for mortgage types or loan amounts. This financing structure only requires a single mortgage loan and allows for a flexible down payment.
Applying for PMI
Since PMI is insurance for the lender, you cannot apply for it directly. Your lender will submit an application to one or more private mortgage insurers while processing your loan. Similar factors that are used to evaluate your loan application are used as criteria for your loan’s PMI.
PMI Costs
The cost of PMI is based on the down payment and mortgage loan type. It generally ranges from .5% to 1% of the home’s purchase value and is passed from the lender to the borrower. Although the premiums paid for PMI are not tax deductible, you are financing a larger loan amount. The interest on your mortgage loan is currently tax-deductible.
Canceling PMI
We offer the best web templates for your business. web templates Our website templates availble for immediate download. The most popular payment options do not require PMI for the entire duration of the loan. PMI can usually be cancelled once you reach 20% equity. Lenders are required to cancel the PMI when you have paid 22% of the home purchase price. Your lender will tell you how to request PMI cancellation when you close the loan and each following year. In addition to having 20% equity, structural improvements and appreciation of homes in your neighborhood help with cancellation approval. You may be required to continue PMI payments for the first 2 years of your loan even if your equity rises because of increasing home values in your area. These guidelines do not apply to special loan programs for borrowers who are classified as “risky” because of credit qualifications. Risky loans and special government program loans may require PMI for the life of the loan. Be sure to clarify the PMI terms with your lender.
In addition to helping with your financing, private mortgage insurers may help you if you run into financial hardships. Do not confuse PMI with other insurances. If something happens to you, and you are unable to pay your mortgage because of a disability or death, PMI does not pay the loan for you. You can still default on your loan. Your house can go under foreclosure, leaving you homeless, and your credit severely damaged. Remember that it is insurance for the lender. If there is a fire, earthquake, hurricane or any other event, PMI does not provide you with any coverage. Although only the lender is insured, PMI companies depend on your ability to honor your loan. In the event that something happens, they will try to work with the lender to help you make arrangements for paying your mortgage.
Sometimes borrowers who can afford to pay the 20% down payment opt to make a smaller down payment and use the money for other purposes: Paying down debt could help improve your credit score, resulting in a better finance rate. Home improvement projects could help accelerate the appreciation of your home. High yielding investment accounts may help you build your wealth more quickly. For those who cannot afford the 20% down payment, PMI helps you purchase a home much sooner than if you had to save the full amount. You will be able to begin taking advantage of tax benefits, enjoy the pride of home ownership and build equity!
© 2006 Informa Research Services, Inc.
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