Why A Mortgage Loan Without PMI Is A Bad Idea.

I was looking over some old documents recently and I came across my 1st mortgage. Ah the memories. I couldn’t believe how high the interest rate was – 6.50% – and that was a good rate for the time!

One other thing stuck out to me – no PMI. Not because we had a 20% down payment; we couldn’t afford that at the time. I had thought at the time that my bank was just better than other banks. See, this was a local bank. A small, home town bank – not one of those big evil banks that would catch all the headlines and hate from the public when the bubble burst years later.

It turns out that my sweet hometown community bank wasn’t doing me any favors by offering me a home mortgage with no PMI. PMI is insurance for the bank to cover their loss in the event that the borrower defaults on the loan. Instead of charging me a PMI premium with my monthly mortgage payment, they rolled this premium into the loan itself.

Is PMI included in the APR a good thing?

On the face of it, things looked great. I had a lower monthly payment without the PMI included. But over the long term, it’s more costly to the borrower because that PMI premium adds thousands to the principal of the loan, which in turn adds thousands in interest over the life of the loan (usually 30 years).

Banks love doing this because it juices their return since you’re paying this premium far longer than you would if it were added to the monthly payment.

Here’s a quick example.

Assume a home value of $200,000, with 5% down. This gives us a mortgage of $190,000. Using the CNN Money PMI calculator with these numbers gives us a monthly PMI of $80.

Since the value of the home is $200,000, and PMI is required until there is more than 20% equity ($40k in this case) this means that the outstanding value on the loan needs to be less than $160,000 (200,000 – 40,000).

Next, using the Mortgage Calculator at Bankrate.com, assuming a loan of $190,000 and an interest rate of 5% (currently high, I know, but historically low) and selecting the “Show Amortization table” option shows that it would take roughly 9 years of mortgage payments before the value of the loan would drop below $160,000.

9 years of mortgage insurance payments is: $8,640 (108 payments of $80)

Rolling the premiums into the loan lowers the monthly payments by $80, but adds 8,640 to the overall loan.

$177,185.99 total interest for base loan of $190,000 and $185,243.29 total interest if PMI is added to the loan amount.

That’s a difference of $8057.30.

Add that to the original amount added to the principal:

$8,057.30 + $8,640 = $16,697.30.

So, the bank wants you to think that you’re saving $80 a month by rolling the PMI into the loan, but you’re really spending an extra $8,057.30.

Caveats.

This is a simple example, but I think a compelling one. It assumes that the borrower is keeping this loan for the full 30 years. If you took out this sort of loan and refinanced or moved in 7 years, you’d come out ahead. But then again, you can’t always refinance – as millions of homeowners who owe more than their homes are worth now realize.

Traditionally, a healthy housing market would have some appreciation involved, which would also shorten the time before that magic 20% value is reached, but that would make the PMI included in the APR even worse.

The bottom line is that you never really know how long you’ll have the loan for or what your home will be worth in 10 years time. It’s my opinion that planning conservatively is best. Be at peace with the idea of holding the mortgage for the full term, and don’t count on rising home values to bail you out. That way, you can weather the storms and anything else is gravy.

Related Posts:

• Save Money on Insurance – Skip These Insurance Policies You Don’t Need!
• What Is a Bad APR?
• Notice of Mortgage Protection Insurance, a Scam.
• Will Refinancing My Mortgage Save Me Money?
• 4 Tips For Applying For a Mortgage

How to Save on Mortgage Costs, Including Refinances.

Closing costs for a home range from 3-6% on average, and most lenders require at least and additional 5% down payment.

My wife and I have bought two houses, sold one house and refinanced once. Here’s how we’ve saved on our closing costs, mortgage and more – and you can too!

Have the seller pay the closing costs

Ask the seller to pay some or even all of your closing costs. You can even roll the cost into the selling price, and have it included in your mortgage. That way the seller isn’t really paying for it. This is helpful if you’re short on cash for the closing, but you do end up borrowing more in the long run. Also, Freddie Mac and Fannie Mae limit the amount you can roll into the mortgage to 6% of the purchase price, and only if you’re putting at least 10% down. Similarly, FHA allows up op 6% and the VA allows up to 4%.

Shop mortgage terms.

Don’t just accept a mortgage from the bank you keep your savings or checking account with. Shop around. Get quotes from at least 3 or 4 lenders, or 2 lenders and a mortgage broker. You’ll want to get at least 2 lender quotes on your own to verify that the mortgage broker isn’t piling on excessive fees. In fact, if you just get 2 quotes from local banks you should almost certainly get a better deal through the broker, otherwise the broker isn’t really getting you anything. After all, the whole point of a broker is that he has the connections and does the leg work to get you a better deal than you could on your own.

When you get quotes from lenders on your own, be sure to get a copy of the
Good Faith Estimate, or if you’re refinancing, a copy of the HUD-1 form.

Eliminate the PMI.

Personal mortgage insurance is usually required if you have less than a 20%down payment, but not always. I shopped about 4 lenders when we bought our last house, and I ended up going with a local bank (that I was not yet a member of) because they had no PMI requirement, offered a quarter percent of my rate if I opened an account and signed up with direct deposit. The interest rate is horrible, of course, but I use ING and HSBC online for savings anyway. Alternatively, if you’re in a high tax bracket, ask the lender if you can pay a single PMI premium up-front, and roll that into the loan. You’ll be borrowing more money over all, but you’ll get to deduct more on your taxes, so it may offset the PMI premium.

Shop around for title insurance.

Many lenders will try to automatically direct you to their affiliated title insurance provider, but you can often times shop around for a cheaper one on your own. According to a recent Kiplinger article, as much as 80% of your title insurance fee goes to the commission of the title insurance agent. That’s a hefty discount if you go it alone!

Pay more (often).

Go with a Bi-Weekly Mortgage Payment Plan if you can – and if there’s no additional fee. Another reason I went with my local bank is that they offered a Bi-Weekly mortgage payment plan for free as a perk to get my business! This saves me years off my time to pay off my mortgage and thousands in interest. I can even make extra payments above that, if I want.

If the lender wants a fee – any fee – to enroll you in a Bi-Weekly Mortgage Payment Plan, opt out. As long as there are no pre-payment penalties, you can still make an extra payment every year on your own, it just takes a little extra discipline.

There are a host of other tips out there, and I’m sure some readers have a few of their own. Maybe if we’re lucky, they’ll leave a comment about one.

Related Posts:

• Why A Mortgage Loan Without PMI Is A Bad Idea.
• Bankruptcy Can Prevent You From Refinancing Your Mortgage – Even With A Credit Score Of 700!?
• Why I’m NOT refinancing My Mortgage.