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

Notice of Mortgage Protection Insurance, a Scam.

I had never heard of Mortgage Protection Insurance until a week ago. I usually only get bills and credit card offers in the mail these days, but last week I got something new. Here’s how it happened…

The case of the misleading mailing.

The mailing was a nondescript brown envelope with an unfamiliar return address and nothing else on the outside besides my address and red letters that looked as though they were hand-stamped and read:

“Requested materials inside”

Requested materials? I don’t remember requesting any materials from anyone.

At first glance it seemed like a credit card application. I’ve received many in unmarked envelopes like this and even a few with “URGENT” printed in red on the front. But this seemed just different enough to make me curious.

When I tore into the envelope, I discovered a half-page typed form stating in large letters at the top:

“Notice of mortgage protection.”

It looked important, and had “return promptly” printed off to the side in bold lettering. Then I saw that everything below that heading was a bunch of fill-in-the-blank questions, with very detailed information about me and my mortgage.

Whoever this was knew the exact total outstanding amount of my mortgage. Once I saw that they were asking if I or my spouse use tobacco, I realized what this was – a life insurance product. My eye moved to the bottom and read:

“Pay your mortgage with your life insurance policy!”

I say this is a misleading mailing because I never requested anything from anyone about Mortgage Protection Insurance. Furthermore, the mailing was meant to look like something I should fill out and return ASAP or I might be jeopardizing my mortgage, and hence my home. I have no idea even who the insurance company is or how they got my info, though I assume my bank sold it to them as one of their partner relationships that I cannot opt out of.

What is mortgage protection life insurance?

So enough about this scam mailing, what is Mortgage Protection Insurance, and is it a good idea?

Mortgage Protection Insurance (MPI) is essentially a life insurance policy that will pay off the outstanding balance on your mortgage if you die before your house is paid off. Sometimes disability insurance is included, so your mortgage payments will be made for you in the event you become disabled and cannot work.

It is also sometimes called Mortgage Payment Protection Insurance (MPPI).

MPI vs. PMI – What’s the difference?

The financial services sector and insurance companies love their alphabet soup of acronyms. MPI and PMI sound similar, but they are two very different things.

PMI stands for Private Mortgage Insurance. You are required by law to pay for PMI when you purchase a home with less than 20% down payment. Private Mortgage Insurance is not for you and it’s not to pay your mortgage if you lose your job. It is solely for the bank, and it pays their insurance policy on you in the event that they need to foreclose on the property. Essentially, it helps mitigate the bank’s loss on the property if you default on your mortgage and there is less than 20% equity on the property.

Mortgage Protection Insurance on the other hand has nothing to do with the bank.

MPI is life insurance you buy from an insurance company and its only purpose is to pay your mortgage in the event you die. Another variant of this includes disability insurance, to make your mortgage payments if you become disabled and find yourself without a paycheck.

Reasons not to buy Mortgage Protection Insurance

There may be some cases where Mortgage Protection Insurance makes sense, but I think there are many reasons it doesn’t makes sense most of the time. Here’s why…

The first, and most obvious case is when you own your own home. No mortgage? No sense in paying for an insurance product that you could never benefit from.

Unfortunately, I do not fall into that category as I still have a mortgage I will be paying off for the next 20 years.

So here are the reasons I will not be buying MPI anytime in the foreseeable future:

1. I already have a life insurance policy, and my mortgage was considered when determining the amount of the policy.
2. Mortgage Protection Insurance is a waste of money.

Consider this: one of the main reasons for getting life insurance is to replace your income if you die. The idea being that your beneficiaries can have that money to use as they need. Paying off the mortgage should be one of the expenses factored into the coverage amount. One major problem with MPI is that the when you die, the insurance company will send a check directly to your mortgage company. Your beneficiaries have no choice in the matter.

What if your spouse wants to sell the house instead?

What if paying off the mortgage doesn’t make financial sense?

Consider that today’s mortgage rates are historically low. Rates will eventually rise, and most likely inflation will rise with them. So, it’s entirely possible that someone who takes out a mortgage today or refinances at today’s low rates and who is faced with a life insurance payout 10 or 15 years from now will be in a situation where they would actually make money putting that lump sum in a high yield savings account instead of paying off the mortgage.

Just such a situation happened in the early 1980′s. A person receiving a lump sum could have made 18% a year by putting that money in a money market account. Contrast that with the potential 7-10% mortgage rate and you’ll see why it was a money loser.

But it’s even worse than that. When the insurer pays the benefit for Mortgage Protection Insurance, it’s paid directly to the mortgage company- not the beneficiary. The beneficiary has no control whatsoever over the money, but worse still – MPI is a declining-benefit policy!

It’s called a declining-benefit policy because while the premium payment remains constant, the payout is reduced over time to keep up with the declining outstanding mortgage amount. That means you end up paying a steady amount in premiums, and get less back over time.

Compare that with fixed, lump sum payout of a standard life insurance policy and you see why MPI really only benefits the insurance company, not the insured.

As I see it, Mortgage Protection Insurance is a bad idea (generally speaking) because:

• You have no control over how the benefit payout is used – it pays off the remaining mortgage, and that’s it!
• The amount you receive in payout goes down, while premiums stay constant.
• Standard term life insurance is a better buy because it provides greater control and flexibility over how the payment is used, and provides a larger payout relative to MPI over time.

Given these reasons, and those stated further up, I’m taking a pass on Mortgage Protection Insurance.

Related Posts:

• Save Money on Insurance – Skip These Insurance Policies You Don’t Need!
• Why A Mortgage Loan Without PMI Is A Bad Idea.
• Cheat Sheet: How to Buy Life Insurance (Infographic).
• Life Insurance Settlements: A Bad Deal?
• Mortgage Protection Using Life Insurance from Mutual of Omaha.

What Do People Spend Their Money On?

I came across this article on Yahoo! finance that details the 5 things that consume 50% of your lifetime earnings and thought I’d share it with my readers.

It’s kind of a catchy headline, right? I know anytime I see something about spending 50% of my income, I tend to take notice. But it’s more or less the big ticket items you’d expect. Here’s the list, and what I think about each. Feel free to add your thoughts in a comment.

Related Posts:

• Which Debt Should You Pay Off First?
• Never Take Out a Car Loan Again! (in 5 Simple Steps).
• Ending America Saves Week With Advice on Saving.
• Save Money – Skip College!
• The Typical American Family Can’t Afford The Typical New Car!

Government Stimulus Doesn’t Work in Housing Either.

Remember when the government subsidies for buying new cars ended and car sales tanked? Looks like we’re seeing the same thing in the housing market. It shouldn’t be surprising that Mortgage Purchase Applications Plummet As Tax Cuts Expire because when you subsidize an activity, you get more of it. When you take that subsidy away, you get less of that activity.

This is a pretty good indicator because the number of refinances rose 14.5%, while applications for new home purchase dropped 20% over the previous month. Rates are still very low, so it’s a logical conclusion that people are no longer as motivated to buy a house since the new home buyer tax credit expired in April.

In fact that is the conclusion of the Mortgage Bankers Association:

” The data continue to suggest that the tax credit pulled sales into April at the expense of the remainder of the spring buying season. In fact, this drop occurred even as rates on 30-year fixed-rate mortgages continued to fall, and at 4.83 percent are at their lowest level since November 2009,”

This is exactly why government subsidies and stimulus don’t work. They only provide artificial economic activity over the short term, but they cannot correct for imbalances in the market. They cannot prevent a recession or a pullback in economic activity, they can only postpone it.

Things have been looking good lately – on the surface. But how much of that economic “recovery” has been an illusion created by stimulus spending that only masks the underlying problems?

Related Posts:

• Mortgage Refinance Trends: New Wave Spurs 6-Week High Demand.
• U.S. Mortgage Refinancing Applications Rose in the First Week of 2010.
• A New Wave of Adjustable Rate Mortgages About to Reset.
• New Home Sales Down 7.6% In December.
• Why The Tax Credit For First Time Home Buyers May Be A Bad Deal For You.