Avoid Private Mortgage Insurance
Avoiding PMI Can Save You Hundreds off Your Mortgage Payments
Private Mortgage Insurance (PMI) adds a heavy burden to borrower's mortgage payments. Many borrowers look to avoid it with a second loan, but is prepayment better?
Why are there so many line items on your mortgage statement? Whatever happened to just principal and interest? This is what most buyers want to know as they take a look at their first mortgage statement. More importantly, borrowers want to know how they can eliminate these lines and lower their mortgage payment. While there are not many items buyers can eliminate, there is one that can be worked around, Private Mortgage Insurance (PMI).
What is Private Mortgage Insurance (PMI)?
Private Mortgage Insurance is insurance required by the bank in case you default on your loan. This is required by all banks if you have less than 20% equity in your property. Most buyers typically put 5% or less down, so PMI is very common. Before you ask yourself why you have to pay insurance for the bank, remember that without PMI the risk to the bank would be much higher. This would in turn leave you paying higher interest rates or unable to obtain loans without putting 20% down. Check out this article on Sub-prime Lending to better understand the perils of higher risk lending.
How can you avoid PMI?
The easiest way is to put 20% down or to buy a property well below market value. Your 20% equity stake is based upon an appraisal by the bank. If they appraise your property significantly higher than what you paid, your PMI will be eliminated. But, most buyers don’t have a hefty 20% down payment, so what can they do?
The most common option is a second loan to make up the short fall. If you have 5% you can get a second mortgage of 15% to eliminate the PMI. Watch out here though because a lot of people end up paying more for their second mortgage than they would if they simply paid the PMI.
Should you take out a Second Loan?
First, remember that once you establish a 20% equity position in your home, it can be reappraised and the PMI can be eliminated. In hotter markets this may only take two to five years, while in cooler markets it may take upwards of ten years. When you consider a second loan, understand that your interest rate will be higher and that there will be cost associated with originating the loan. This is an upfront cost that can be significant in comparison with the smaller PMI payments.
Additionally, the interest payments may be tax deductible, but there is still a portion of that money that you will never get back, much like the PMI you would be paying. When choosing a second look at your total interest payments and all loan fees. If these add up to more than five years of PMI payments, consider prepaying your first loan and building equity that way. By taking the payments you would have made to your second mortgage and applying them to your first, you could probably cut your PMI period down to five years or less.
Be careful when trying to eliminate PMI. Many people take out second loans when it is really better to just prepay their first loan down to 20%, and then have their property reappraised. In addition, don’t forget to have your property reappraised. Many people end up paying PMI for far more years than they should. The insurance company is the only person that wins in this situation. For some helpful tips on appraisals, check out this article on How to Influence Appraisals.
