Learn how to avoid the clutches of Private Mortgage Insurance (PMI)
By Sadiya Anjum
If you cannot afford that down payment the lender may tell you the only viable solution is to get a Private Mortgage Insurance. Perhaps this is the easiest solution but it is not the only solution. If you can avoid PMI then you will be saving a lot of money in the long run. Private Mortgage Insurance basically covers for your outstanding mortgage in case you fail to pay it. The lender is assured his money while you pay the money and premiums for the insurance. The only benefit you take away is the capacity to obtain a loan with little or no down payment.
PMI is expensive, not tax deductible and can easily add about $100 or more to the borrower’s monthly payments. PMI is in the best interest of the lender but it is hardly reassuring to the borrower with the knowledge that in addition to his own loans, taxes and insurances, he has to shell out more money for another insurance which does not benefit him in the long run. But there are ways that you can work around this, only if you have some patience and put some effort into it.
The ideal solution to avoid PMI is to break up your loan into two portions – ‘80-10-10’ or ‘80-15-5’. This basically means you get a first loan for 80% of the purchase price and the second one for 10% or 15%. The other 5% or 10% you can put down in cash as a down payment. The first loan for 80% will not require a PMI as this insurance is required only if you borrow over 80% of the purchase price of the property. Second mortgages never require a PMI. This kind of mortgage is also called as a ‘piggy back mortgage’. The interest rates for these loans vary and you may be a charged a few points extra on this loan. However, it will be worth it as you will be completely avoiding PMI.
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Another solution is to think of getting a sub-prime loan. A sub-prime loan is offered to people who have a bad credit history or cannot afford to put down a decent amount as down payment. FNMA guidelines are not enforced on these loans, hence they do not require PMI. But sub-prime loans are marked with higher interest rates. So you need to judge your situation and see which option will be best for you.
You may also consider one of the more popular loan options today – HELOC – meaning Home Equity Line of Credit. A HELOC is somewhere between a regular mortgage and a credit card. If you have enough equity on the house, you can get a line of credit based on it. When you are purchasing a house, the bank gives you a line of credit for the complete value of the house with which you can actually buy the house. In this case a credit limit is usually set, against which you can withdraw as and when you please.
Another simple way of subtracting PMI from your loan is if you agree to higher interest rates. Some lenders may be willing to let go of PMI if the interest rates satisfy them. The problem here lies in the fact that while a PMI can be eliminated completely once you pay off 80% of the original purchase price or the appraised value of the home at the start, an interest rate is going to stick with you till then end.
If you have already surrendered to a PMI, there is a simple way of getting rid of it as soon as possible. The real estate market is growing steadily each year and the value on some properties is increasing accordingly. Some homes have even doubled or tripled in value over the past few years. You should spend some money and get your home appraised. If the equity has risen, then you maybe able to get rid of the PMI sooner than you expect. But the terms regarding the PMI should be checked for clauses requiring a certain period of time to pass before you can drop it entirely.
Most homeowners fall prey to PMI simply because they have not explored other options. But before you adopt any of the above mentioned alternatives, you may want to analyze your situation closely. Each of the above methods has its own drawbacks; in terms of money too, you need to check if the PMI or the higher interest rates work out cheaper for you. Understand your situation and choose accordingly.
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