If you make the decision to purchase a house then start saving your money well in advance. It is in your best interests to save enough to be able to have a 20 percent down payment. If you decide to buy but only have 10 or 15 percent to put down on your home(or less) then your lender is likely to deem it compulsory for you to buy private mortgage insurance (PMI) before you will be granted a mortgage. The purpose behind this kind of insurance is to protect the financial institution in the event that you default on the loan.
Should You Buy Private Mortgage Insurance
In a roundabout way you may think after reading this that private mortgage insurance is a viable alternative for saving up the money for a down payment on a home. You can just buy the insurance instead of saving the 20 percent or more that is required for a down payment from the vast majority of mortgage lenders. There are cases where it is the only option and also cases where it is a good option for would-be new homeowners. However there are also a variety of reasons why buying this kind of insurance is not in your best interests at all. Let us take the time to look at those reasons now.
Private mortgage insurance will cost you between 0.5 percent to 1 percent of the amount you pay on your loan on a yearly basis. To use a concrete example of this, if your home loan is $100,000 and the PMI fee is 1 percent then you will pay approximately $1,000 a year (or $83.33 per month). This is a fair amount of your hard earned money. This actually could be even worse. According to the National Association of Realtors the average new home costs $240,000. What this means therefore is that a family could be spending as much as $200 a month on private mortgage insurance. This is an awful lot money to have to pay out!
As of 2007 contracts for PMI are considered to be tax deductible if the married taxpayer earns less than $110,000 in adjusted gross income on an annual basis. For those married couples who wish to file their taxes separately the amount is $55,000 a year. This means that many families with two incomes who have combined earnings that take them just above the threshold amount set down by the IRS will not be able to deduct the amount of private mortgage insurance they pay from their taxes. This is very discouraging for many people. What this translates to for many homebuyers is that making a sizeable down payment on a home makes more sense then buying PMI because at least in this case the interest on the home loan is tax deductible.
If you pass away your heirs will not be left with any monetary compensation from the private mortgage insurance contract. The lending institution is the sole beneficiary of a PMI policy and it is the proceeds for this policy that are paid directly to the lender (as opposed to first being paid indirectly to the people you leave behind). If you wish to protect your loved ones and make sure they have some money if you were to die suddenly then you will need to purchase a separate insurance policy. Bear in mind that private mortgage insurance is in place to help the mortgage lender as opposed to helping you. This is not what any aspiring homeowner wants to hear but it is the truth.
Private mortgage insurance can be tantamount to giving your money away (but not in a good way by any means!). Those who put down less than 20 percent of the price of the house they wish to buy will be expected to pay mortgage insurance until the point at which the total equity of their home has reached the 20 percent mark. For many people this can take a long, long time and can add up to lots of money that is given away in the meantime. To gain a better sense of perspective on this, if you and your spouse are paying $208 a month on private mortgage insurance and the home you own is worth $250,000 then it would be very wise for you to take the money you are spending monthly on PMI and invest it into a mutual fund. Look for a mutual fund that would earn you an annual compounded rate of return of eight percent. If we assume that this money is not taxed then in a 10 year period it will grow to $37,707.
As previously stated, most of the time when the equity a homeowner has built up reaches 20 percent it is no longer is necessary to pay private mortgage insurance. However canceling the PMI contract is not as simple as ceasing to make the payments. The process of canceling PMI can sometimes take months and plenty of headaches to cancel. There are many mortgage lenders that deem it a requirement for homeowners to write a letter requesting that the insurance be canceled. Many also require a formal appraisal of the house before it will be cancelled. This tends to vary from lender to lender but it can be a mentally exhausting process to go through.
Not all lenders require the same things of those who take out private mortgage insurance for their homes. It is worth noting that some lenders expect the homeowner to maintain the contract for the insurance for a designated duration of time. What this means is that once the individual has reached the 20 percent threshold he or she is still obligated to continue to pay for this type of insurance. This is something you need to find out about BEFORE you buy the policy. Read the fine print of the contract and speak with your lender about this before you decide to purchase private mortgage insurance. The more informed you are from the start, the better off you will be later on.
Up to this point we have drawn a very bad picture of private mortgage insurance. The good news is that it is not all bad news. For many American citizens private mortgage insurance is tax deductible. For those who bring in less than $110,000 on a yearly basis PMI can be deducted when tax time comes around. To a couple who has a mortgage worth $250,000 and an annual PMI payment of $2,500 (which is approximately one percent of the outstanding loan) this deduction, depending on the tax bracket the couple is in, could mean annual savings of $300 to $400, or in some cases more. This is something to cheer about for sure!
Another important thing to note is that PMI can sometimes (but not always, depending on the lender) be paid up front. If you groan at the thought of having to pay PMI on a monthly basis then some lenders will give you the option of paying it in cash when you start your mortgage loan. There are instances where a discount will be offered if it is paid up front. This is something you may or may not want to do, depending on your financial circumstances. Another thing that some mortgage lenders offer to their customers is the opportunity to add the one-time up front fee to the balance of the outstanding loan. There is an advantage to this which is that when the monthly cost is amortized over a span of 25 or 30 years it is generally quite low.
Only you can decide if purchasing private mortgage insurance (PMI) is in your best interests or not. Of course it also depends upon your financial circumstances, the amount of money you have for a down payment on a home and the amount of money you are looking for in a mortgage. Look at it from every angle and weigh the benefits against the pitfalls before you make a final decision
