If you are looking to purchase a home for $200,000, do you have $40,000 in your bank account that you want to or can use for a down payment? Well, if you are like me, I can think of a lot of other things that I would rather use my money for like my 401K retirement plan. If you do not have this much money available to purchase a home, then you need Private Mortgage Insurance PMI. Unlike the past decade or so, PMI has its advantages.
What Is PMI - Private Mortgage Insurance?
PMI was developed many years ago to provide a way for homebuyers, such as yourself, to purchase a home with less than a 20% down payment all the way to no down payment. How is this? Lenders are only protected by their insurance on their money up to 80% of the value or sales price of the house they are lending money on. What this means is that if you borrow money from a lender (get a mortgage) and you default on your payments (stop making payments to the mortgage company) the lender can get back from their insurance company up to 80% of the money that you borrowed from them.
Well, losing the other 20% is pretty risky for a lender so PMI was developed to cover a portion of the other 20%. In our example, if you borrow $200,000 and default on your mortgage, then the lender is only going to be able to get paid back from their insurance $160,000. Now with PMI, they can get some portion of the other $40,000 back too. With PMI being in place, lenders are able to lend up to 100% of the sales price with a lot less risk to their money.
Piggy Back Loans - 80/20 Loans Instead of PMI Loans
Since the late 1990s, PMI has had a bad rap. Many mortgage professionals, including myself, have sold piggy back combo loans to homebuyers instead of loans that required PMI. These combo loans were set up so that you would get two mortgages, one for 80% of the sales price and one for up 20% of the sales price. When these two are combined you end borrowing up to 100% of the sales price of the home you are buying. For example, if you are purchasing a home for $200,000 and you were getting an 80/20 combo loan then the lender would give you a first mortgage for $160,000 and a second mortgage for $40,000. The first mortgage has a lower interest rate than the second mortgage (piggy back). The piggy back has a higher interest rate because they are riskier loans to make.
Why these loans were popular was because the mortgage interest payment for both mortgages was/is tax deductible while the PMI payment was not tax deductible. Also with the combo loan, interest rates on the first mortgage could be much lower because of reduced risk. However, since the beginning of 2007, two things have made these loans all but disappear as lending programs that mortgage professionals can offer.
PMI May Be Tax Deductible - Check With A Tax Advisor
The first reason is that since the beginning of 2007, PMI payments under certain conditions are tax deductible. It is still in question as to whether the tax deduction will remain in play after 2008. Please check with your tax consultant about the tax deductibility of your PMI payments in 2007 and beyond. The second reason these combo loans are hard to get now is a result of the problems that the mortgage and real estate industries suffered throughout 2007. Piggy back loans are considered high risk and investors and mortgage lenders have cancelled offering these programs because of the tremendous risk and loss that they have suffered in 2007.
This article is part 1 of a two part series on PMI. Part 2 is called: Private Mortgage Insurance - Types - Benefits - How Long You Will Have It
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