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| The Basics | Save hundreds on your mortgage easily
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You may be able to easily cut your monthly mortgage check by $43 a month or more. All you have to do is refigure the value of your home and cancel private mortgage insurance when your equity reaches 20%.
By Terry Savage
Homeowners: Could you use an extra $516 a year?
It sounds like one of those "too-good-to-be-true" television commercials. But the truth is, you may be able to easily cut your monthly mortgage check by $43 or more. That's how much private mortgage insurance (PMI) adds to your monthly payment -- and you may be paying when you don't have to.
If you have made your loan payments on time, and either made some extra payments or can prove that your home has appreciated substantially in value, you may be able to cancel that PMI policy and cut your monthly bill.| Avoiding PMI with a piggyback loan | | If you only have a 10% down payment saved up, some mortgage brokers suggest you take out an 80% loan, thus avoiding PMI by also taking out a second mortgage loan for an additional 10%. Then you have two loans, and two payments. But this can be a costly process, involving double sets of fees. And the interest rate on the second loan is most assuredly higher than the rate on the first loan. Plus, you're stuck paying on the second loan until it's paid off. With a PMI policy, the insurance payment stops when you reach the 80% equity level. While it may look cheaper at first to take out such a "piggyback" loan, you have to consider the long-term consequences. For a financial calculator that compares costs over the long run, check out PrivateMI.com, the Mortgage Insurance Companies of America's Web site, with the link on the left.
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What is PMI -- and who benefits?
Conventional loans generally require the borrower to put down at least 20% of a home's purchase price. With that much cash invested, few homebuyers will walk away from a loan, even if times get tough or home prices drop. But requiring a 20% down payment can push homeownership beyond the reach of many families, especially in this era of rapidly rising home prices.
That's where PMI comes in. It allows you to get a mortgage with a smaller down payment. PMI allows homeowners to make as little as a 3% to 5% down payment and still qualify for a mortgage. Or put another way, it allows you to buy a larger and more expensive house with the money you've saved up for a down payment.
It's insurance that the buyer pays for -- but it protects the lender's interest. That is, if the buyer defaults on his mortgage, this policy guarantees that the lender will receive the principal amount of the loan.
Several major insurers, including PMI Mortgage Insurance, Mortgage Guaranty Insurance Corporation and Radian Guaranty, offer this type of insurance, which is taken out at the time the lender grants your mortgage. Although you'll fill out an application, the lender will actually seek out the insurance. But remember, you're paying to protect the lender in case you default.
What is PMI costing me?
While it adds to your monthly payment, PMI is the extra edge that allows you to buy the home of your dreams. On a $100,000 mortgage with a 10% down payment and an 7.0% interest rate for 30 years, the monthly principal and interest payment would be $665. If the homebuyer has a good credit history, the mortgage insurance policy would typically add about $43 a month to that payment.
So how do I stop paying PMI?
Private mortgage insurance should no longer be required once you've made enough payments to bring your home equity up to the 20% level, or you can demonstrate by appraisal that the home has increased in value enough to bring your equity above 20%.
The Homeowners Protection Act now requires that the lender automatically cancel PMI when you have 22% equity in your home -- as long as you have a good payment record -- but the law only applies to conventional mortgages originated or refinanced after July 29, 1999. (A good payment record means you don't have any payments 60 days past due in the preceding two years, or 30 days past due in the year preceding your request for cancellation.)
(The law does not apply to two of the most popular government-subsidized loans -- FHA and VA loans. The FHAs mortgage insurance program extends for the life of a loan you take out. The VAs home loan program has a mortgage guaranty feature; you pay a fee to get the loan. The only way to escape the additional cost of insurance on an FHA loan or the VA guaranty fee on a VA loan is to refinance the loan.)
But if yours is an older conventional mortgage, you may be paying PMI unnecessarily and not know it. Few people realize it's the responsibility of the homeowner to notify the lender when their equity surpasses 20%. As a result, many people have paid PMI premiums for years longer than necessary. It can happen more easily than you might think in a rising real estate market.
How long should it take to build up that level of equity?
If the only way to build equity was through regular monthly payments, the time required to reach 20% would be easy to figure, based on the amount of your down payment, the mortgage interest rate and the length of your mortgage. Building up equity in those early years can be excruciatingly slow. For example, if you put down only 3% on a 30-year mortgage at 8%, it would take you 12.7 years of payments to reach that magic 20% loan-to-value ratio. Even if your down payment were 10% on that 8% mortgage, it would take you 9.3 years of payments to reach a 20% equity level. (At lower interest rates, the level is reached slightly sooner.)
What if I make extra principal payments or if my home goes up in value?
That's where your diligence comes in. In many areas of the country, home values are appreciating at a rate of 3% to 4% a year. So for the borrower putting 10% down, it takes just four or five years to reach the magic 20% equity, instead of 9.3 years. Even for new loans that automatically cancel PMI, it's still up to you to alert your lender if you reach that point earlier than expected.
If you've made additional principal payments, or if homes in your neighborhood have increased dramatically in value, you should contact your loan servicer to request that PMI be canceled. You'll have to pay a few hundred dollars for the appraisal, but it certainly could be worth it if you save years of unneeded premium payments.
The bottom line
Private mortgage insurance gives the lender protection to make a loan that is not quite "standard" when a borrower's down payment is less than 20%. It can make the difference in the buyer's ability to become a homeowner. But it is insurance paid by the homeowner to protect the lender from a default.
And although PMI on newer mortgages will automatically be canceled in future years as equity is built up through on-time payments, that won't happen automatically on pre-1999 mortgages. And cancellation won't be automatic if rising home values allow you reach 20% equity ahead of schedule.
So pay attention to that monthly PMI payment and your home's market value. Canceling PMI early could save you a nice hunk of money every year.
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