Avoid
PMI - Private Mortgage Insurance
by Matthew Killikelly
Home ownership is synonymous with the American
Dream. Yet, the road to home ownership has become
harder to travel in recent years as home prices
increase faster than the average buyer can accumulate
their required down payment and closing fees.
Thus, many consumers find it increasingly difficult
to accumulate enough money for the traditional
20% down payment and 3-5% closing costs required
to purchase a home. Hence a $200,000 purchase
would require as much as $50,000 for down payment
and closing fees with the buyer required to
retain a reserve of several thousand dollars
after the transaction as a safety net. With
the increased cost of living it's harder than
ever to hit such numbers.
Years ago, in an effort to capitalize on niche
markets, banks began to offer loans that required
a private mortgage insurance policy (PMI) but
allowed borrowers to venture past the traditional
20% down payment mark. The PMI policy defrays
the risk of low down payment loans to lenders
and opens up home ownership to a greater portion
of the public. Needless to say, the use of private
mortgage insurance comes at a cost to the consumer.
The fact is PMI insurance can cost hundreds
of dollars per month. Fortunately, there's a
less known and, in my opinion, an underutilized
method to accomplish the same objective that
costs far less.
By creating two loans, one larger, primary mortgage
and a second smaller, subordinate mortgage the
consumer can bypass the need for PMI insurance
with none of the costs associated with PMI.
In industry terms this is known as using subordinate
financing or "piggybacking" a mortgage.
Lenders accept this practice because even without
the PMI policy there isn't one loan exceeding
80% of the property value. The end result for
the borrower is the same as taking a PMI loan
without the added expenses. Therefore, it costs
much less to piggyback a loan than pay for PMI.
Unfortunately, in most low down payment situations
a lender or broker will direct borrowers to
the PMI loans. My question has always been:
If piggyback loans offer a better and cheaper
alternative for borrowers why would PMI loans
still be so common?
PMI loans are still common for a couple of reasons.
First, many banks and brokers are simply not
aware of piggyback programs or do not understand
them fully. In this case, bear in mind that
most retail banks, your bank branch on the corner,
do not train the branch employees in their programs.
Sadly most retail "loan officers"
are simply taking an application and forwarding
your information to an underwriting center.
Through lack of training they are not empowered
to strategically guide you through your process.
Nor does the bank want to go out of their way
to avoid PMI policies because the entire cost
is to the borrower and not the bank. Add in
that creating a PMI policy is easier than making
two loans and you'll start to understand that
a bank or broker would really be dedicated to
putting the borrower's interests first to go
that extra mile. If the truth be told, it's
apparent that many companies are quite content
to allow borrowers to take one loan and allow
the borrower to pay PMI policies to mitigate
the risk.
In the second case when the banks and brokers
are aware they can piggyback a loan to their
borrower's benefit they often choose not to
do piggyback loans because they amount to twice
the work. It's just a lot easier for a bank
or broker to do one loan instead of two. So
if the customer does not object to paying PMI
insurance or inquire about subordinate financing
it is not offered. In light of the hundreds
of dollars a month they could be saving their
clients this is a sad commentary on our industry.
The entire expense of the PMI policy is absorbed
by the borrower, so when a customer takes a
loan covered by a PMI policy the bank is covered
in the event of a foreclosure. Remember that
the whole reason PMI exists is to mitigate a
bank's risk if they are asked by the borrower
to lend more than 80% of the property's value.
Essentially, the piggyback loan doesn't directly
mitigate the risk of a high LTV loan as effectively
or as easily. Therefore it would seem that the
age of PMI lending will remain in full force.
To consumers that just means that the need to
be educated and ask for what is best for you
is all the more important.
This method of piggybacking loans can also be
useful in other ways. The other huge benefit
they can be used for is avoiding jumbo loan
status. At this moment in time the conforming
loan limit is $359,650. Any loan that exceeds
this amount is considered a jumbo loan and will
be about a half a percent (.5%) higher than
a conforming loan. Some loans that exceed the
conforming limit by no more than 25% can be
broken up as piggyback loans as well to lower
the available rates back to conventional rates.
This can also represent a huge monthly savings
as well.
One cannot totally vilify lending institutions
for the use of PMI: after all these are the
very institutions that invented and presently
allow the piggyback alternative. It just isn't
clear to me that, given a clearly better alternative
for the client, a more robust effort is not
made throughout the banking industry to make
customers aware of this option. The loan representatives
in my company regularly offer piggyback loans
as an alternative to PMI. Once the benefits
are made clear our customers take this option
almost every time. We consider this a strong
selling point for ourselves and our company,
telling our customers "Let our expertise
save you money".
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