The PMI Threshold

Once you reach that magic threshold amount, your mortgage insurance is discontinued. This can happen in a few different ways: you can make extra payments to pay down the difference quicker, or you can just make your regular payments for several years until 20% of the loan has been paid down. You can also change the course of your mortgage insurance payments by refinancing, or using a new loan with different terms to pay off the old one. In any case, when you cause an investor (your lending company) to take on a perceived increase in risk, they are essentially saying that you need to pay them for that privilege.

Calculating PMI Rates

An average figure for PMI is 1/2 percentage point annually. That means that if you purchase your home for $200,000, you would multiply that by one-half percent (0.005) to find your annual payment, and then divide that amount by 12 (or however many mortgage payments you make per year). This will give you the amount each month you can expect to be paying for PMI if your down payment is less than 20% of the total sales price of your home.

It’s important that you understand the implications of every aspect of your mortgage. You need to see how the length of its term affects you, and you may not be cognizant of this if you haven’t already taken a moment to stop and consider it. Let me preface the rest of what I am about to say by telling you that it’s more important to make your payment every month than it is for you to worry about getting a loan with a shorter term that you can’t as easily afford. Time flies when you’re having fun, but I want you to be aware of what time does when you owe someone money.

Loan instruments are available to suit just about everyone’s personal needs because, well, they make it easy. Anyone who could potentially earn money by giving you money is going to create as many paths as they can to allow that to happen. So while the standard mortgage is setup to last thirty years, there are also standard 15-year mortgages, along with less common 10- and 20-year loans. With the recent housing boom we’ve seen the advent of the 40-year loan, which as I will explain in a moment, is a ridiculous proposition.

Length Matters

As I’ve said on another page of this website, compound interest on a loan is always paid on the remaining balance of that loan. The shorter your loan term, the larger your payments have to be to get that loan paid off in time. The loan balance is reduced more quickly and the amount of interest you’re paying on that balance is likewise decreased. Interestingly enough, the amount you have to pay extra on a shorter loan is not as much as you might think.

What if I told you that there was a way you could save about $140,000 on a $200,000 house? That would sound pretty ridiculous. Well, technically you could. That doesn’t mean you’d buy the house for $60,000. A home costs much more than the sales price when you factor in interest, but by reducing your loan term you end up saving an incredible amount of money.

With a total cost of over $455,000, you can see that after you’ve added interest into the mix that $200,000 house starts to look a little bit more expensive across thirty years. So why wouldn’t everyone just go with a 15-year loan instead? That’s pretty simple; it’s a little thing called lifestyle.

While the 15-year loan in the scenario above would find you with a paid-off house (and thus without any payment at all) in half the time, the shorter loan does come with a short-term price: $478.07. That’s how much more your monthly payment would need to be for those fifteen years to make the shorter loan happen. Aside from the people who may not be able to afford this higher payment, there are many others who can but simply don’t want to go without the extra cash. Our lives revolve so much around instant gratification that it’s hard for anyone, myself included, to think about forking over another $500 for no immediate, tangible benefit.

Pre-Payment

Still, there’s good news for those of you who might already be on the big thirty-year lockdown. You can add extra to your monthly payment whenever you want, and because of how interest works this amount goes directly toward paying down the principal. The vast majority of mortgages will allow you to do this, except for crappy ones that charge fees when you pay more than you have to. Check with your loan officer to make sure you have this option. It just might save you some money!

Nothing Like A Present

By law, the seller of the house you want isn’t allowed to give you money for a down payment. You can ask them to pay your closing costs and that is perfectly legal and common in practice, but they can’t actually provide any of the amount the house costs. You have to be able to prove to your lender that the money you’re using for the down payment is yours and that those dollars have come out of your own personal funds.

There is a way to get around this, however. It’s called using gift funds and it’s one of the most common legal loopholes you may ever come across. No one who services your loan – not your lender, or the government – can “officially” verify that this is taking place. They know it happens all the time, but there’s no law against it. Update: apparently there is legislation in the works that may override this statement, so the remaining contents of this article may no longer be feasible if this legislation is passed.

How Gift Funds Work

The process of procuring first home buying experience; not only is this an ideal setup to begin with but it does allow you to receive gift funds.

Buyer (you) and seller must agree that you are going to participate in a gift funds program. The loophole part of it works like this: the seller makes a contribution to the organization in an amount equal to your down payment, plus a small processing fee. The charitable folks at said organization then provide you with a friendly donation which happens to be in the same amount, because they care about you so much and want you to be able to afford your first home.

The benefit to the seller is that they have opened their home up to a larger pool of buyers by providing a small percentage of the sales price, which will often mean a shorter period on the market and thus a faster sale.

Gift Organizations

There are two major players in the gift funds arena, although there are probably several smaller organizations that provide similar assistance. These companies are both registered non-profits, and are the most widely known and used for this purpose. The information below will help you find out more about each one and make a decision about whether you’d like to participate in one of their programs.

The Nehemiah Program

http://www.getdownpayment.com

The Nehemiah Corporation of America specializes in community development and is composed of several smaller units and affiliates. Their gift funds program has been around since 1997 and is perhaps the largest in the nation.

AmeriDream

http://www.ameridream.org

AmeriDream supports home buyers with several initiatives including education and loss mitigation, and their first time home buyer financing program is one of the best.

Down Payment

Under standard practices (ie., NOT those of the past few years) lenders require a large portion of the home’s sales price to be covered by the down payment. Usually the maximum allowable loan is 80% of the amount you buy the home for, meaning you have to come up with the other 20%. A borrower who takes out an FHA loan, on the other hand, can be eligible to receive up to 97% of the sales price. For those of you who may be a little rusty on your mental math, that means that with an FHA loan you can put as little as 3% into a down payment. You will probably still have to pay PMI if you put down less than 20%, but paying a few extra dollars each month tends to be preferable to coming up with several thousand dollars more in order to get a loan in the first place!

Interest Rate

Most of us are aware of the dangers of subprime lending. Don’t be scared off by an FHA loan if you think I’m going to tell you that you’ll get a lower rate than what everyone else is getting. By default, mortgage rates are a few percentage points higher than the prime rate. So there’s a little bit of room for them to work with you. Also, regardless of how much (or little) you trust Uncle Sam, at least be assured that the government itself does not make a habit of creating administrative departments that purposefully provide hazy loan terms and don’t tell you the whole story. As a matter of fact, here’s an External Link Alert! The website of our helpful Department Housing and Urban Development.

Debt-to-Income

I’ve mentioned what this keyword means elsewhere, so I’ll get right to the point here. FHA loans allow this amount to be bigger; the amount of your mortgage payment as it relates to the total income you bring in per month is legally allowed to be higher than it is with a conventional loan. Still, you have to eat and buy shoes / movies / antiques / stickers / sports memorabilia / celebrity toenail clippings / whatever else you buy for a hobby, so don’t over-extend yourself if you’ve got a lot of monthly bills you can’t get out of. If you’re used to paying rent, you’ll find that in your first home buying experience a mortgage and everything associated with it can be a much more daunting task. In general though, these limits are put in place to keep your mortgage payment from swallowing up your entire paycheck:

Debt-to-Income Ratios

Compare these figures with today and we’ve got a much different picture. Median income is in the $40,000 per year range, with median home prices across the U.S. just under $200,000. That’s about 5x gross salary!

It has become quite apparent to me that ‘the good old days’ ended way before I was born.

Even with the recession in housing prices, we are still well above our means when it comes to real estate affordability. This has resulted in a shift in lending practices toward saddling the average homeowner with excessive amounts of mortgage debt, especially for those in the first home buying category who don’t have experience or knowledge about what’s best for them. Unfortunately there’s a lot of smoke and mirrors used in the industry. I’m not trying to sound cynical on purpose (or maybe I am subconsciously), but the truth is that most newer mortgage formats have been created chiefly to make it easier for the working stiff to buy now and pay later. Dearly.

My ARM Is Growing

One of the most common unconventional mortgage loans created to get Joe Six-Pack into a home now and let him worry about how he’s going to make his payments a few years down the road is called an ARM, or Adjustable Rate Mortgage. They come in 3-year, 5-year, 7-year, and I believe less often in 10-year flavors.

The ARM allows a purchaser of real estate to enjoy a low fixed rate for the first part of the loan. When that time is up, the interest rate begins to change, based on the federal funds rate and other key market factors. These changes alter the amount of each mortgage payment, sometimes quite drastically. This can be a significant shock to dear Joe the homeowner, who may not have the income to support such a rapidly changing expenditure.

The Old-Fashioned Way

A fixed-rate mortgage is just that – it stays the same for as long as the loan is meant to last (30 years, in most cases). Your initial interest rate on a conventional mortgage will probably be slightly higher than the opening rate of an ARM or other teaser loan would be. But like a MasterCard™ commercial, not being surprised by a random payment amount every month? Priceless.