 Dear
Dr. Don,
Currently my husband and I owe $145,000 on our
house. It would newly appraise at about $185,000.
We have a good mortgage rate at 6 percent, but
pay private mortgage insurance, or PMI, premiums
of $109 per month. According to our lender, we
cannot remove the PMI (private mortgage insurance)
until we reach 25 percent of the new appraised
value.
We have approximately $10,000 in savings, but plan to use it to buy a car in the near future. Because we are expecting our third child in the spring, the car purchase is a necessity. I don't know what my options are to save the most money.
Refinancing doesn't seem like an
option, based on the closing costs and current
rates. Are we better off putting our savings into
the principal of our home to get rid of the PMI,
and therefore finance the cost of the car? Or,
should we use the savings for the car, so we don't
have to take out a car loan?
We are only on one salary, therefore only have around $100 to $200 per month available for payments or savings. But throwing away $109 per month on an insurance we don't need seems ridiculous.
-- J.M. Mortgage
 Dear
J.M.,
Homeowners hate paying private mortgage insurance, feeling that it's a waste of their money. After all, it's designed to protect the lender, not the borrower. But it's the protection that the insurance offers that allowed you to qualify for your current mortgage at that 6 percent rate.
The Homeowners Protection Act of 1999 spelled out the terms of when a mortgage lender has to cancel PMI, but the decision isn't based on the current appraised value of the home. Instead, it's based on paying down the loan balance to 78 percent of the original purchase price. You can contact your lender to find out how close you are to achieving that loan balance.
However, since your lender told
you your PMI can be canceled at a 75 percent loan-to-value
ratio of the new appraisal, that's the target
I will use in formulating a plan to help rid you
of this insurance.
The law has provisions requiring that homeowners are told -- both at closing and once each year -- about how they can terminate or cancel PMI. Your mortgage servicer is also required to provide a telephone number that you can call for information about terminating or canceling private mortgage insurance.
You did a good job in laying out your three choices: Use the savings to pay down the mortgage to where you can cancel the PMI policy, make a large down payment on a car, or refinance the mortgage and get out from under PMI.
You'll want to confirm this with your lender, but an additional principal payment of $6,250, as shown in the table below, would allow the loan-to-value ratio to reach the point where your lender is willing to cancel PMI based on the appraised value of the home.
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| Path to PMI freedom |
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| Newly appraised value: |
| Loan balance: |
| Loan-to-value: |
| Additional principal payment: |
| Adjusted loan balance: |
| New loan-to-value: |
|
The added benefit to this approach is that you've shaved a couple of years off the life of your existing mortgage and saved thousands in interest expense, not to mention the $109 a month in PMI payments. You'd still have almost $4,000 for a down payment on the car, and the $109 can go toward the car payment.
You could also use a home equity line or loan to buy the car. If you can use the mortgage interest deduction on your income tax return, it will reduce the effective (after-tax) cost of the loan.
Refinancing your mortgage doesn't make sense as a way to cancel PMI unless you can get a better rate. Why pay an estimated $3,000 in closing costs to get a new loan at a higher interest rate just to get out from under PMI, when you can apply $6,250 to the existing mortgage balance and keep your 6 percent rate?
Using the $10,000 as the down payment on the car doesn't do anything about your PMI issue.
You haven't told me how expensive a car you're considering, but a car payment of $209 to $309 isn't
going to buy you all that much car. Try Bankrate's "Monthly auto loan payment calculator"
to see if you can make the numbers work. You should consider buying a used car to avoid taking the
depreciation hit from owning a brand-new car.
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