I received an interesting e-mail in response to ( Banks Lenders Mortgage Loans ) last week's column about how to avoid paying private mortgage insurance. The writer suggested that I was a bit one sided in my thoughts. Let me re-visit the issue.
Lenders require private mortgage insurance (PMI) when the first trust loan amount exceeds 80 percent of the purchase price of the home. The lower the loan amount is in relation to the purchase price, the less risky the loan, so highly leveraged loans (over 80 percent) require PMI.
PMI insures a percentage of equity in the home. This allows lenders to offer loans in excess of 80 percent loan to-value. This is a good thing. Without the availability of PMI, most lenders would require a 20 percent down payment. So PMI opens the doors of homeownership for millions of people who simply don't have that kind of down payment.
But thanks to competition in the industry, there are programs available that allow less than a 20 percent down payment without the PMI. As I mentioned last week, a "piggy-back" option is very popular. Instead of paying PMI, the borrower obtains an 80 percent first trust and a 10 or 15 percent 2nd trust. Since the 1st trust is limited to 80 percent LTV, PMI is not charged.
It's important to know a couple of things: First, the interest rate on the 2nd trust is usually higher. Expect to pay between 7.50 and eight percent. Second, some purchase money 2nd trusts have balloon features. This means the balance must be paid off at a given time - usually 15 years.
Another program I mentioned last week is the "self-insured" loan. Basically, this allows the borrower obtain one loan of up to 95 percent of the purchase price without PMI. The catch? The lender jacks up the rate. Expect to pay at least a half percent more.
Now let's talk about how to cancel PMI. From a common sense point of view, it would figure that once a homeowner has 20 percent equity in the property, PMI should not be charged. Unfortunately it doesn't always work that way. Lenders have varying rules about canceling PMI. Some will flat out refuse, others will require that you pay for an appraisal to prove that the equity is there. At any rate, there's no guarantee that PMI will be dropped even if you have 20 percent equity.
Congress addressed this issue in 1999 and they passed the Homeowner's Protection Act. The law requires that all lenders automatically cancel PMI once the loan amount drops to 78 percent of the original purchase price.
The key phrase here is "original purchase price". The law does not take into consideration any natural appreciation of the property. For example, if you purchased a property for $200,000 and obtained a 95 percent loan in the amount of $190,000. The balance would need to drop to $156,000 before the law would require that the lender cancel the PMI. Making regular payments on a 30 year loan, it would take 139 months, or more than 11 years before you reach this point.
Statistically, folks don't hold mortgage loans for more than about six or seven years. Moreover, a homeowner would be very unlucky if his property didn't appreciate considerably in far less time. So for practical purposes, the law is pointless.
Private Mortgage Insurance, in some cases, is the best alternative when purchasing a home with a small down payment. But in most cases, I think that there are better alternatives. It's important that any homebuyer consult with a knowledgeable loan officer. He can then outline all the options to determine the best course of action. For more information on Private Mortgage Insurance, head to www.privatemi.com.