Calculating the difference In Cost Between PMI and 80-10-10

In order to calculate the benefit of using 80-10-10 financing as opposed to making only 10% down payment and taking a private mortgage insurance, let us take this example of a $200,000 home loan on which you make a 10% down payment.

Cost with private mortgage insurance

When you make only 10% down payment on the above-mentioned loan and get a loan for 90% of the purchase price on a 30 year fixed-rate mortgage with an 8% interest rate, your monthly payment is $1322. The Pvt. mortgage insurance will cost you an additional $70 per month which is not tax-deductible. This makes a total mortgage monthly payment equal to $1400.

Cost with Second Mortgage 80-10-10 Finance

Owner carry second mortgage

If you go for a second mortgage which has been financed by the owner, the calculations of your monthly mortgage payment is going to be slightly different. Let us say you find a seller who will carry a 10% or $20,000 fixed rate second mortgage on the same loan as above. The second mortgage is amortized on a 30 year term. However, as most owners carry second mortgages are short-term mortgages, the loan is due in five years. The seller charges you a 7.5 interest on this mortgage and your payment is $140,. With a 10% down and a 10% second mortgage you only need to pick the first mortgage for 80% of the home value which will come to $160,000 on a 30 year fixed-rate mortgage at 8%. The mortgage payment for this first mortgage will come to $1175 per month. By adding the $140 payment for second mortgage your monthly payment on the home loan will be $1315 which is $85 less than the example above using the private mortgage exam example. The interest on both the first and second mortgage will be tax-deductible. Another advantage is that you can probably pay off the second owner carried mortgage anytime you want whereas the private mortgage insurance can be a little more difficult to get rid of.

The only disadvantage is that the second mortgage is going to be due after five years and you will need to pay back the entire money due on the loan. You’ll be disappointed to discover that because of the amortization schedule almost 94.6% of your original $20,000 that the borrower owner lent you remains to be paid. This is in spite of having made a payment of hundred $40 regularly for 60 months. At this point, many people expect to refinance the second mortgage. However, what if for some reason you cannot refinance it due to a change in financial conditions such as losing your job or the value of the property decreasing? The interest rate on the mortgages could also become a much higher which will make it difficult for you to qualify for a new loan. In this situation the balloon payment on second mortgage could very well destroy your mortgage payment schedule. This is the kind of situation which was referred to when we mentioned that balloon payment loans are also referred to as bullet loans by many mortgage lenders.

In fact balloon mortgages were one of the toxic mortgage loans that resulted in so many foreclosures when the real estate industry crashed in the late 2000s.

Second Mortgage from an Institutional Lender

In this example we consider the same home loan as above but the second mortgage is given by the institutional lenders and not by the seller of the home. You get $160,000 loan at 8% for 30 years as a first mortgage which will cost you $1175 per month. Since you’re dealing with institutional lender, you might get a few options regarding your second mortgage. He might offer you a second mortgage of $20,000, 10%, either as a fixed-rate mortgage, amortized over 30 years but due in 15 as a balloon payment or a fully amortized fixed-rate 15 year loan. You would pay $191 per month for the 30 year fixed-rate mortgage balloon loan with an 11% interest rate versus $225 a month for a 15 year fixed-rate mortgage at 10.75% interest. By examining both these options closely we can see which would cost you less. You would pay $1366 per month for the 15 year balloon payment loan. This mortgage will have a payment of $16,760 due in 15 years. By taking the fully amortized second option you increase your monthly payment by $34 to a nice round $1400 per month. You would also build up equity faster with that second mortgage and there is no balloon payment to worry about. For many people this kind of pressure and eventuality could be the reason why they would prefer to have a second mortgage without a balloon payment looming up. Either of these options from an institutional lender would be preferable to an owner carry second mortgage where a balloon payment will be due in just five years of time. This could become a problem for many homeowners if any emergency or change in financial situation towards the worse were to take place.

The choice between these two options is entirely yours and will depend upon whether you intend it to re-financed the second mortgage as soon as possible to a lower rate. In many situations home borrowers pay off the second mortgage much sooner than 15 years.

What Is The Cost Of Private Mortgage Insurance

The amount that the private mortgage insurance costs you depends on several factors:

Type of loan

ARMs will generally have a higher private mortgage insurance premium than FRM’s.

Loan amount

PMI premium is partially based on the percentage of the loan amount as well. This means that the more you borrow the greater will be the amount of your private mortgage insurance premium.

Loan to value ratio, LTV

Loan-to-value ratio is the ratio between the amount you are borrowing and the amounts that the property is actually worth. The greater this ratio the greater the risk of default to the lender hands, higher will be your PMI premium.

Insurance company issuing PMI

This is not very substantial factor because the interest rate between different insurance companies are competitive and very very little from one insurance provider to another.

PMI origination fees and monthly premiums change frequently. You can check with your mortgage lender for more specific information about PMI expenses on your mortgage.

Even though the rates of the PMI and maybe fairly similar between different insurance providers they could differ with different areas, different states are and the market conditions.

Sometimes certain areas that are considered to be distressed property areas where the values of real estate is declining, are charged with a higher private mortgage insurance. Similarly limited documentation mortgages and mortgages with less than 5% down payment will get charged higher origination fee as well as interest on the private mortgage insurance.

If you are in the circumstances which you are making less than 20% down payment on your home and are not liking the fact that you have to pay for private mortgage insurance as well, you should understand that PMI is not a permanent situation.

The day that you can prove that you have more than 20% equity in your property, you can convince your mortgage lender to drop the private mortgage payment from your monthly mortgage payment.. In order to build up a 20% equity in your home, you can either pay down your loan in the future or it can happen automatically following an increase in property prices in your area. You can also increase the value of your property by doing certain improvements such as adding a 2nd bedroom, modernizing the kitchen, re-doing the plumbing and electricity wiring etc.

Getting the lender to remove the private mortgage insurance will probably require that you get the property appraised to establish its current market value. You will have to bear the additional expense of property appraisal but should not cost you more than $200-$300. If the appraisal is successful and you are able to drop the PMI payment from your mortgage payment it could save you hundreds or more in a year

Private Mortgage Insurance, PMI

Pvt. mortgage insurance or PMI is the insurance that you usually have to pay to the mortgage lender if you are making a down payment of less than 20%.

Pvt. mortgage insurance protects the lender against default by the borrower and covers his losses for the entire foreclosure proceedings . Lenders mostly suffer loss when they have to undergo foreclosure to recover the money that they have lent to the borrower. This is because sometimes the equity remaining in the house is less than the amount owed on the mortgage as well as due to the costs of the foreclosure proceedings.

It is called private mortgage insurance because it is funded by private insurance companies. As mentioned before government agencies like the FHA and VA insured loans given out by their approved lenders. This accounts for almost 20% of the mortgage market. For the remaining 80% of mortgage loans, it is private insurance companies that insure the amount for the mortgage lender.

If you are making less than 20% cash down payment on the mortgage you are an additional risk to the lender. In this case he will make it a mandatory for you to purchase PMI as well. There is usually no option to avoid this has almost all vendors follow this rule.

Pvt. mortgage insurance makes sense to the lender because they believe that for a person who has made less than 20% down payment is more liable to walk away from the investment in the property when things get tough. The person may face financial difficulties in the future, fail to make payments and to make matters worse a recession might cause the property values to drop. In this case the mortgage lender will not be able to recover the money owed on the mortgage through the foreclosure process. Foreclosure means paying Real Estate Commission, property transfer tax and other customary expenses associated with the resale of the house. All this will make it hard for the lender to recover the money he has lost. In fact, this is exactly what happened to many mortgage lenders when the real estate market slumped in the late 2000.

You may be able to deduct your PMI premiums on your federal tax returns.

How much do you have to spend on the PMI

The amount that the private mortgage insurance costs you depends on several factors:

Type of loan

ARMs will generally have a higher private mortgage insurance premium than FRM’s.

Read more: How Much Does A PMI Cost