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Archive for the ‘Private Mortgage Insurance (PMI)’ Category

Second PlaceUnless you are putting 20% down on your home purchase, odds are you are familiar with second mortgages.  Second mortgages are usually smaller loans used by lenders to make up a financing gap.   For instance, you can only put 5% down, so your loan is structured as an 80-15-5. The first mortgage is 80% of your purchase price and you receive a second mortgage for 15% of the purchase price.  Together, both loans equate to 95% combined loan-to-value.  You only have to come up with a five percent down payment and avoid paying private mortgage insurance

While most people tend to focus on the interest rates and loan types of the first mortgage, choosing the right second mortgage is also a part of the puzzle.  Second mortgages come in two flavors – home equity lines of credit (HELOCs) and closed-end second mortgages (CES).  While both serve the same purpose, there are some subtle differences between the two.

HELOCs:  The main characteristic of the HELOC is that they basically turn your house into a credit card.  HELOC debt is revolving.  This means that as you pay the initial loan down, you can continue to borrower against the equity.  For example, you have a HELOC with an initial balance of $100,000.  You receive a bonus and decided to pay down the HELOC to $50,000.  Because HELOC debt is revolving, your credit line is still $100,000 and you now have access to $50,000 in equity ($100k credit line – $50k principal balance = $50k in usable equity).   Many people tend to use their HELOCs to pay for vacations and weddings, buy cars, and pay off credit card debts when the principal balance is paid down lower than the total available credit line.  

The rates on HELOCs are usually tied to the Prime Rate which the interest rate that banks usually charge their most valuable and stable customers.  The Prime Rate is always the same across banks and currently stands at 8.25%.  When you hear of the Federal Reserve raising interest rates, it directly impacts the Prime Rate.  Most HELOCs usually have a final rate of Prime plus or minus a margin which is usually determined by your creditworthiness.  For example, the most credit worthy borrowers may get an interest rate of Prime for life.  This means the rate on the loan is whatever the current Prime Rate happens to be.  Obviously, having an adjustable interest rate can help or hurt you depending on which way the market is headed.   Three years ago, the Prime Rate was at 4%.  Obviously, many homeowners were caught off guard with the rising rates seeing thier payments increasing substantially.  However, if the Federal Reserve starts cutting interest rates, homeowners with HELOCs would benefit.

The other characteristic of HELOCs is that they loans have an interest-only feature.  This means you only have to pay the interest each month, instead of both principal and interest.  Depending on your situation, this could be a benefit.  Most HELOCs have ten year amortizations. 

Closed End Seconds: During the refinancing boom, most consumers preferred the HELOC because Prime rate was as low as 4%.  However, as the Federal Reserve has continued to raise the Fed Funds rate which directly impacts the Prime rate, HELOCs have lost quite a bit of their luster.  Enter the closed end second mortgage (CES).

A closed end second mortgage is basically a regular mortgage loan.  Nothing fancy.   The interest rate on a CES is fixed which makes them very attractive in unstable and rising interest rate environments.  There is no risk.  You know exactly what your payment will look like for the life of the loan.  As the Prime Rate increased, CES mortgages gained in popularity because the fixed rate was cheaper than than the adjustable rate on the HELOCs.  Top credit borrowers in the current market right now can see rates in the upper sixes to low sevens, substantially better than the 8.25% HELOC rates.

CES mortgages can be amortized in 15 years, 20 years, 30 years, or be a 30/15 balloon.  The 30/15 balloon is the most common.  This means the loan payment is based on paying back the loan over 30 years, but in year 15, you are required to pay off the loan by making a large balloon payment.  If you plan to move or refinance prior in fifteen years, this should not be an issue.

Generally, CES mortgages do not allow you to borrow against the mortgage as you pay down the principal like a HELOC.  However, there are a few lenders who have been rolling out similar features, but they are uncommon.  Once you pay the loan off, it is gone.  The credit is not revolving for future use.

As always, if you have any questions, don’t hesitate to give me a call.

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TaxesAfter much lobbying, private mortgage insurance (PMI) is now tax deductible for refinance and purchase loans taken out after January 1, 2007.  This benefit was buried deep in the Tax Relief and Healthcare Act of 2006.  This is great news for millions of homeowners making owning a home more affordable.   For decades, lenders have required homeowners who do not have a 20% down payment or at least 20% equity in their homes to pay PMI.  PMI is an insurance policy the lender takes out on you to insure that if you were to default on the mortgage, the lender would recoup their money.  Put another way, it is an insurance policy you pay for but provides no benefit to you.  It doesn’t help you if you default, it helps the lender.   There used to be absolutely no financial reason to ever elect to pay PMI and it was to be avoided at all cost if possible.  PMI can be several hundred dollars per month depending on your credit profile.

While this is great news, do not mistake this bill passing as something being done as an act of kindness.  PMI companies have seen their policy revenue fall dramatically over the past several years with the development of piggyback mortgages.  A piggyback mortgage is where the loan officer breaks your mortgage up into two pieces.  They give you a first mortgage of 80% of the purchase price and a smaller second mortgage for the remaining balance.  For instance, if you only had five percent as a down payment you would get an 80% first mortgage and a second mortgage for 15% and you would put five percent down.  By structuring the loan this way, you do not have to pay the PMI charges.  The combined payment with the two mortgages is lower than one mortgage with PMI.   Piggyback mortgages have saved homeowners thousands of dollars.  In fact, I probably only close a handful of transactions annually with PMI because there are plenty of ways to avoid it for most borrowers.  Typically, if PMI is required it is because there are no other options.

This bill is the result of lobbying by PMI companies so they wouldn’t find themselves out of business.  Nevertheless, it is still a good thing.  However, even with PMI being tax deductible it still probably won’t be better than avoiding it altogether.

The main points of the bill are:

  • Homeowners making less than $100,000 per year may deduct the full cost of the annual mortgage insurance premiums
  • If adjusted gross income is above $100,000, the deductible portion of the premium is reduced by 10% for each $1000 or fraction thereof.  Now in english: this means if you make $101,000, you can deduct 90% of the mortgage insurance premiums paid.  This also means the maximum income allowed for the deduction is $110,000.
  • Mortgage loan (purchase or refinance) must have been closed in 2007.  This means you won’t be able to deduct the premiums on your taxes this April.  You have to wait until next year.   PMI premiums paid in 2006 are not deductible.
  • Only primary and second homes are eligible.  Rental income disqualifies the second home deduction.

If you obtain a mortgage this year with PMI, make sure you talk with your tax professional about this new benefit to fully take advantage of it.  Mortgage insurance company, MGIC, has a good presentation on the bill.

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It used to be that when you bought a home and didn’t have a twenty percent down payment lying around, you had to pay what is known as private mortgage insurance (PMI). PMI is insurance that the lenders requires borrowers to pay to insure that the lender recoups their funds on your mortgage in case you default on the loan. PMI can add hundreds of dollars in additional costs to your monthly housing payment. The bottom line is that PMI is bad for consumers. It is bad because it is expensive. It is bad because it not tax deductible. It is just plain bad. In essence, you are paying for insurance that does not benefit you at all. It is like paying for car insurance on a car that you don’t have the luxury of driving.

The good news is that there are now plenty of ways to avoid paying PMI. The most common way is getting what is known as a piggyback mortgage. A piggyback mortgage is when the lender breaks your mortgage up into two pieces. The lender will give you a loan for 80% of the purchase price of the home and a separate loan for the remaining balance. For instance, if you are buying a $300,000 home and want to put 5% down. The lender will give you a first mortgage for 80% of the purchase price or $240,000. Then you will get a second loan for 15% of the purchase price or $45,000. By structuring the loan this way, your total monthly payment will be cheaper than having just one loan with PMI.

This loan structure has become so popular that almost no one pays PMI anymore unless there is absolutely no way to get the loan done without it. As a result, lenders created what is known as lender paid private mortgage insurance (LPMI). Basically, instead of having a separate charge for PMI, the lenders rolled the cost of the insurance into the interest rate.The theory is that having a slightly higher interest rate without PMI is better than having two mortgages. Additionally, since the PMI is part of the interest rate, it is now tax deductible. Occasionally, this option works best for some people. However, in most circumstances, I have still found the piggyback approach to be cheaper overall.

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