Private Mortgage Insurance
Homeowners hate paying private mortgage insurance, or PMI. But PMI helps solve a problem: the eternity it takes to save up for a 20 percent down payment.
If your down payment is less than 20 percent of the home’s price, you almost certainly will have to pay mortgage insurance. You pay for it, but the lender benefits. The policy protects the lender in case you default — a likelier possibility if you made a small down payment.
One alternative to paying for mortgage insurance is to keep renting and saving money for years, until you’ve accumulated enough to make a 20 percent down payment on a home. Or you could put up a small down payment, pay mortgage insurance, and contentedly live in your own home before you’re old.
As explained in this article on the basics of mortgage insurance, PMI charges vary depending on the size of the loan and of the down payment. The charges typically amount to 0.5 percent to 1 percent of the loan annually.
You pay mortgage insurance premiums until your equity passes the 20 percent threshold. That can take a long time. Let’s say you make a 10 percent down payment on a $100,000 house and you get a 30-year mortgage at 7 percent interest. You owe $90,000. Your monthly payment for mortgage insurance is roughly $40.
You can stop paying for mortgage insurance when you owe less than $80,000 — in other words, when your equity is greater than 20 percent. At the above rate and terms, it will take more than eight years to build up to 20 percent equity unless you make extra payments toward principal.
Eight years is a long time to pay for mortgage insurance. On the other hand, some folks might consider an alternative — paying rent for eight years while saving up for a down payment — to be a waste of money.
There’s another way to dodge mortgage insurance, and that’s to get a piggyback mortgage. It works this way: You’re buying that $100,000 house and you can afford a 10 percent down payment, so you need to borrow $90,000. You borrow $80,000 at 7 percent interest for 30 years and, as a second mortgage, you borrow $10,000 at 8.25 percent interest for 15 years. The second mortgage costs about $97 a month, which costs more than PMI, even when you count the mortgage interest deduction. And you’re paying it for 15 years instead of eight.
Don’t dismiss piggyback mortgages without looking into the details of a particular transaction. Sometimes a lender can come up with a piggyback loan package that’s cheaper than paying PMI.
Sometimes you can cancel PMI early by having your house reappraised at a higher value. Home appreciation is added directly to your equity — so if the value of your house is rising rapidly, you can pass that 20 percent equity threshold quickly.
Unfortunately for homeowners, loans that are underwritten according to Fannie Mae or Freddie Mac guidelines — in other words, most mortgages — have to “season” for two to five years before you can cancel PMI strictly because of value appreciation. Bankrate.com’s financial advice columnist Dr. Don explains it in greater detail in this column. The bottom half of this mortgage analysis from May 2002 explains it, too.
There’s another kind of insurance you buy when you buy a house or refinance: title insurance. It’s an unusual kind of policy because it protects against something that might have happened in the past, rather than something that might happen in the future.
Title insurance protects the lender or owner from disputes over ownership of property. When you buy real estate, someone checks land ownership records to find out if the seller has the right to sell it and collect the full payment.
Perhaps the seller is divorced and needs the ex-spouse to sign a document allowing the sale to go through. Or maybe an unpaid electrician put a mechanic’s lien on the property, ensuring payment when the property is sold. The county might have filed a lien to satisfy unpaid taxes. And, of course, the mortgage lender has a lien on the property, ensuring that the loan is repaid before the sales proceeds go to anyone else.
The title search is designed to dig up all of these things and more. Later, if there is a dispute and a lawsuit over ownership of the property because the title search was faulty, the title insurer pays legal fees and any settlement amount. When you pay for title insurance, you’re paying for two things: the title search and the insurance policy that pays the costs of future legal proceedings.
There are two kinds of title policies when you buy a house. One covers the lender (you have to pay) and the other covers you, the buyer. You’ll always be required to get the former, and it’s often a good idea to buy the latter.
A prominent private mortgage insurance company called Radian Group has introduced an alternative to title insurance for home equity loans and refinancings. It is cheaper and faster than title insurance and it has been controversial.
U.S. Sen. Phil Gramm, R-Texas, once suggested making title insurance optional, but it appears that the notion wasn’t taken seriously.