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Dear Dr. Don,
What are the relative advantages (and disadvantages) of putting down at least 20 percent of the cost toward a
mortgage, as opposed to a smaller percentage? How much is required for mortgage insurance at closing -- and over
the life of the loan?
As with the prepayment example, could you compute how much difference would it make over 30 years,
assuming a fixed rate of 6.25 percent, and a modest house price (e.g., $300,000)? Inquiring minds want to know.
-- Sharon Selects
Dear Sharon,
The primary advantage of making a down payment of 20 percent or more of the home's purchase price is that the mortgage
lender won't require you to have private mortgage insurance. A secondary advantage is a smaller monthly mortgage payment.
The disadvantage, if there is one, is that you've put equity to work in investing in real estate
that you could have invested elsewhere. This argument is typically put forth by people who want to invest in the
stock market, and it's a tough argument to make this year with weakness in stock and real estate markets.
Although your loan can be structured to pay PMI premiums at closing, PMI policies typically charge
a monthly insurance premium that the homeowner pays until the policy is canceled. You need to talk to the lender to
determine when PMI is paid.
The policy won't last the full term of the mortgage loan. Lenders are required to cancel the policy
when the homeowner's equity position, from principal repayment, reaches 78 percent of the original purchase price.
The FTC's Facts for Consumers Publication
"Cancellation
of Private Mortgage Insurance: Federal Law May
Save You Hundreds of Dollars Each Year" has
more on this topic.
Rather than give you a formula for
calculating PMI, several mortgage Web sites have
PMI calculators. I like the one on the
Home Mortgage of North Carolina Web site.
In appreciating real estate markets, you can make the argument that paying PMI with a smaller down
payment actually saves homeowners money because they're capturing that appreciation rather than waiting to buy until
they have a larger down payment.
Alternatives to PMI like piggyback
loans and lender-paid mortgage insurance also
allow consumers to finance a home without a large
down payment. The Mortgage Professor, Jack Guttentag,
has a calculator on his Web
site that lets you compare the approaches.
Recent tax law changes allow some
taxpayers to deduct the premiums paid for mortgage
insurance through 2010. The Bankrate tax tip "Deducting
private mortgage insurance payments" has more
information on this topic.
You're right to want to consider the total cost of how you choose to finance your home, including the
cost of any PMI premiums. That's the approach you should take in choosing the size of your down payment and whether you
should pay PMI.
What is my total interest expense? What are my estimated PMI premiums? How much tax savings do I receive
from making these payments?
Keep in mind that the size of the down payment is also influenced by your level of savings, the need for
an emergency fund and your investment alternatives.
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