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Laurie Gardner     Laurie Gardner
Senior Mortgage Loan Originator
Alaska USA Mortgage Company NMLS Unique ID #204060
Phone: (907)796-1202 / fax 907-929-6711
Fax: WA Consumer Loan Co. License #CL-157293
License: Mortgage License #AK157293
Alaska USA Mortgage Company NMLS Unique ID #204060
January 2007

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PMI: New Legislation Could Change Everything

PMI: New Legislation Could Change Everything

News Flash! Congress and the President have just created a benefit which could impact the majority of Americans seeking home financing! Millions of home buyers may now qualify for a more expensive home or obtain a lower payment for the same-priced home while potentially reducing their taxable income.

So, what is this bombshell? The federal government has passed legislation that would allow for Private Mortgage Insurance, also known as PMI, to become tax deductible effective January 1, 2007. The benefit will be extended to those whose personal adjusted gross income is $100,000 or less per year.

What is PMI?
PMI is normally required for home loans that exceed 80% of either the property's value, or the agreed upon sale price, as listed in the home purchase agreement. The purpose of PMI is to protect the lender in the event that a borrower falls into default and the lender has to reclaim the home through foreclosure.

Why Stay Away from PMI?
The majority of those seeking home loans view PMI with contempt. The primary reasons for this are its perceived high cost and the fact that, prior to the new legislation, PMI was not tax deductible. Typically, prospective homeowners would only consider a loan with PMI because they had no other option available.

When lenders allowed for "piggyback" financing in the 1990s, this enabled homeowners and home buyers to finance a home without PMI. Borrowers could simply take out two loans that, together, would cover the total amount borrowed. In this type of transaction, the first mortgage accounted for a minimum of 80% of the purchase price or appraised value of the home; and the second mortgage covered the remaining amount required to fund the transaction.

What are My Options?
Let's take a look at a sample transaction to see the financial impact of these different loan scenarios, especially in light of the new legislation. In the case of a home valued at $250,000, the mortgage transaction would require PMI if the amount of the first mortgage were to exceed $200,000. Alternatively, the borrower could take out a first mortgage for $200,000 or less, along with a second mortgage for the remaining amount needed to close.

Using the example above, if the homebuyer were looking to finance 95% of the purchase price, then one of two scenarios would typically take place: 1) The homebuyer accepts two mortgages, a first mortgage of $200,000 and a second mortgage in the amount of $37,500; or 2) The homebuyer finances a single mortgage of $237,500 and pays the PMI premium.

Using current interest rates, and without taking into consideration property taxes and homeowners insurance, the breakdown for monthly payments are shown below. The examples assume that the homeowner took out a 30-Year Fixed Rate at 6.25% and a Home Equity Line of Credit (HELOC) with interest-only payments at a rate of 8.75%. (Rates for both are subject to change and will typically decrease when the borrower puts more money into the transaction.)

  Loan Scenarios
Loan with PMI
Piggyback Loan
  First Mortgage Loan Amount $237,500 $200,000
  Second Mortgage Loan Amount $37,500
  Monthly Payment Options    
  First Mortgage Payment $1,462 $1,231
  PMI Payment / Second Mortgage Payment $154 $273
  Total Monthly Payment(s) $1,617 $1,505
  Total Cost Analysis    
  Total Payments made after 60 Months $95,150 $90,292
  Principal Paid $15,824 $13,326
  PMI / Interest Paid $79,326 $76,967
  Balance Left on Loan(s) $221,676 $224,174
  Total Cost $79,326 $76,967
  Monthly Tax Benefits    
  First Mortgage Payment $408 $344
  PMI Payment / Second Mortgage Payment $51 $90
  Total Monthly Tax Benefits $459 $434

In this case, the homeowner has two possible mortgage payments to choose from. With PMI, the total required mortgage payment would be $1,617. With piggyback financing, the payment would be $1,505. Over the course of five years, this would result in a monthly cash flow savings of over $6,700. While this appears to be a relatively simple decision based on the numbers alone, there are other things to consider here.

HELOCs Have Teeth
When deciding whether to accept a HELOC, it's important to keep in mind that the interest rate is subject to change on a monthly basis. Each time the Prime interest rate moves, your monthly payment will most likely change as well. Anyone who elected to take out a HELOC three years ago has probably seen their interest rate increase from 4.50% to 8.75%. Based on the loan amount in our example, the minimum monthly payment would have increased from the initial payment of $133 to $273 due to interest rate changes alone!

The other thing to keep in mind is that the balance on your second mortgage will not decline if you choose to pay only the minimum amount required each month. After five years of making only the minimum payments, the total remaining balance on your loans would be nearly $2,500 higher than it would be had you chosen a loan with PMI.

The Gift from Congress & Other Benefits of PMI
Under the new ruling from Congress, borrowers who choose to accept a loan with PMI could potentially see as much as a $610 reduction in their yearly income taxes.

Another reason to consider PMI, which many people aren't aware of, is that it can make it easier to qualify for a loan. Whenever a first position home loan is accompanied by a HELOC, the approval of the first loan is contingent upon the approval of the second. In many cases, the approval requirements for second home loans are more stringent than those for loans in first position. Alleviating this obstacle may enable you to buy a more expensive home or to purchase preferred upgrades today instead of in the future.

The second reason to rethink an aversion to PMI is that it doesn't last forever. If your home appreciates at a rate of 4% annually, you will be in a position to have it removed by your lender in four years. This would result in an automatic reduction in your monthly payment of $154.

What to Do Now
When considering a home purchase or the restructuring of your finances, the first thing you should do is call your mortgage professional. There are a wide variety of options to consider, beyond what has been presented here, and your mortgage professional will help you to determine which scenario will best fit your needs. Your financial security starts with a phone call.

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