Buying your first home is a major milestone. There’s nothing quite like the giddy
rush that comes from knowing you could paint a wall fluorescent pink or cover the cabinets in peanut butter and no one could legally stop you. You’ve also got a new and quite big investment you need to maintain. Weighing the freedom against the responsibility is a delicate balancing act, and doing it successfully is part of what being a homeowner is all about
PMI in a nutshell
Close your eyes and imagine yourself as a venture capitalist, like those you may have seen on “Shark Tank.” An inventor comes to you and says they’ve got a killer new product. They need $300,000 now and they’ll repay it with 4% interest over the next 30 years. If they don’t, you can take the manufacturing equipment they’re going to buy with your loan, which is worth about $250,000.
This isn’t a great deal for you – the venture capitalist – since you’re putting the remaining $50,000 on the line, and that’s not considering the cost of selling their equipment! They’re not risking anything. The equipment was bought with your money. You need to know they’ve got something at stake, too. So, they put up $30,000 of their own money. This is a better deal, but you’ve still got more to lose than they do.
This is where an insurance company comes in and says that, for $3,000 a year, they’ll protect the loan. If the inventor fails to deliver, they’ll repay the balance of the loan at that point. Sounds great, but who’s going to pay it? If you do, that just raises the amount you’re going to lose on this deal. Instead, you make the inventor pay it.
That’s how PMI works. The home buyer, in this example, is the inventor, and the lender is the venture capitalist. To make the mortgage an attractive option for lenders where scenarios like this happen, the home buyer needs a way to ensure the lender will be made whole (paid back in full) if something goes wrong. Importantly, PMI is protection for the lender, not the borrower. If you fail to make your mortgage payments, you will still face foreclosure even if you’re paying for PMI. All that changes is the institution that issued your loan can recoup its losses.
Who has to pay for it?
Not all mortgages require PMI. In general, loans made where the principal total is 80% or less of the sale price of the home don’t require PMI. If you put 20% down, lenders see that as a sign that you’re a safe risk. You’ve got as much skin in the game as they do.
Home buyers with a down payment of less than 20% may have to pay for PMI. Typically, costs are between 0.5% and 1.0% of the total value of the loan, with riskier loans requiring higher PMI payments. Sometimes, lenders offer loans to these home buyers that exclude PMI, but in order to make the increased risk worthwhile, such loans come with a higher interest rate.
PMI premiums can be made one of two ways. You may notice a line item in your mortgage estimate or statement that identifies your monthly premium for PMI. In other cases, it may be included with the closing costs as a lump sum. Some loans require both a payment at closing and an additional monthly premium.
When can I stop paying for PMI?
The 20% rule is a helpful one here, too. Once you’ve paid down enough of the loan to have 20% equity in your home (meaning your loan amount is less than 80% of the home’s market value), most lenders will no longer require PMI. Every month, a portion of your mortgage payment goes to paying interest, and a portion goes to paying the principal. The second part is how you increase your equity. Think of it as gradually buying your home back from the lender. Of course, you can make extra payments beyond the mortgage payment to reduce the principal faster and increase the percentage of home that you own.
Even with a 20% stake in your house, you may have to pay for PMI a little longer. Policies are generally purchased for a year, and monthly payments are held in escrow to cover yearly premiums. You may have to continue paying the premium until the year in which you reach 20% equity ends. Also, if you happen to live in an area where home values have risen, investigate the ability to get a new appraisal if you are paying PMI. If your home has gone up in value enough to get you pas that 20% threshold, you may be able to request cancellation of the PMI on your loan.
While PMI may seem unfair, remember that without it, lenders would be less likely to issue mortgages in the first place. PMI helps borrowers qualify for loans on homes they might not otherwise have been able to purchase. That means it helps put you in a nicer house without saving more for the down payment.
A friend of mine teaches at a university where the 2008 financial crisis came up during one of his recent class discussions. He asked his students, “If you had one million dollars and a time machine, could you go back to 2008 and make a profit?” The class replied that they couldn’t. Not one student believed he or she could have turned a profit from the financial crisis. He was troubled by that, so he asked his other classes the same question and no one indicated that they understood what happened well enough to do so. Finally, he asked his colleagues, and even they were stumped. A few of them had vague ideas or suggested they would just buy stock in Google or Amazon while it was low. Still, none had a firm enough grasp on the events of that autumn to confidently explain how they could have made money.
One trillion dollars is a lot of money. If you’d like to imagine that, think of a heist movie where the protagonist walks off with one million dollars in a duffel bag. Now, imagine there are one million duffel bags, each with one million dollars in them. Or, if you’d prefer, think of the Dallas Cowboys, who were valued at $1.7 billion in 2009, one of the few NFL franchises to gain value during the year after the financial crisis. That same year, Cowboys Stadium, now known as AT&T Stadium, opened with a price tag of $1.2 billion. As the most valuable NFL franchise playing in the most expensive stadium in the country, both could be had for just shy of $3 billion. So, America lost as much money that month as it would take to purchase the entire NFL 10 times.
As 2015 draws to a close, it’s time to figure out if you’re in your best possible financial shape. While performing a self-audit can seem a daunting task, we’ve created a simple way to get started. Below, we ask three questions about where you are now compared to where you were a year ago. Your answers should help you understand if you made the right choices in 2015. After that, we’ve got three more questions to help guide your 2016.
2015: Do you have less debt than a year ago?
December can be a rough month for our credit card statements, so you might already be dreading the daily arrival of the mail just as much as your kids eagerly anticipate it. But debt is part of life, and the kids can’t unwrap a copy of the family credit score, so you grit your teeth and swipe. Don’t let the fact that you have credit card debt be a source of guilt or shame, and definitely don’t assume that burden even if you are carrying some credit card debt into 2016. Instead, take a look at where you are now, then compare it to where you were a year ago. Have you reduced your debt in 2015? If not, why not? Maybe you had an emergency you needed to cover. Maybe this was the year you installed the home theater you’ve been wanting. The important thing to ask yourself is whether you’ve reduced your credit card debt, and if not, is what you bought with that debt worth it to you now?
If it’s time to clear up your debt, try one of our home equity or personal loans. Or, if you have higher rate credit cards, transfer the balances to a lower rate Destinations Credit Union MasterCard Credit Card. If you reduce your rate and make the same payments, your debt will dwindle more quickly.
2015: Do you have more money saved than you did a year ago?
Again, the best way to determine your financial position today is to compare it to where you were a year ago, and savings is important. If you have more saved this year than you did last year, it means your budget is working and you’re headed in the right direction. If you have less saved than you did a year ago, try to determine why that is. Did you have to dip into savings to pay the down payment on a long-term purchase? Did you have to cover a gap in employment? Just like with debt, figure out how much less you saved, compare it to what you bought, and determine whether or not the purchase was worth it.
Just like with debt, however, simply looking at the bottom line probably isn’t enough to tell you if you’re making the right moves. Having an emergency fund that represents six months of your income is incredibly important for easing your family’s mind and protecting them if something unfortunate happens. But having an emergency fund much larger than that isn’t necessarily better. You don’t want to be a dragon, sleeping on a hoard of gold simply because it’s pretty. Instead, put that savings to work for you in the form of a retirement fund, college savings or even the down payment on a second home to use as a rental property.
If you’re looking to add to your savings, check out our savings plans (hint: if you want to earn a really high rate, attach a Kasasa Saver to a Kasasa Rewards Checking and earn more every month you qualify!). To save for a child’s education, take a look at our Coverdell IRA Plan.
2015: Is your credit score higher than it was a year ago?
These questions might not look like they go together, but they do. This is the section where you take a big-picture look at your financial world. If your credit score is improving, then you’re probably making the right choices overall. If not, it would be good to find out why that is the case. Make sure all of the charges on your credit report are accurate, work to tackle your debt, and try to bring in more income. If you work to improve your credit score, you’ll almost certainly have to improve your overall financial standing. Destinations Credit Union Members can get unlimited free financial counseling to help you with this through our partnership with Accel.
But your credit score isn’t your life. What are you going to do this year? Are you going to take a trip to Europe? Get started in a new career? Buy a vacation home on the lake? Learn a new language? What is it you’d like to actually do?
Once you know what you want to do this year, figure out what it’ll take to make it happen. Can you save for it? Will you need a loan? Is your credit score too low for a second mortgage? Whatever is in your way, make that your next financial goal. Get your savings and debt into good positions, and then try to live your life. After all, that’s what the money is for.
You may have noticed a surge in the number of ponytails and slightly exposed tattoos around the workplace water cooler. Or perhaps you find you now need to get to the office earlier if you plan to land a space for locking up your bike. Maybe you’ve had to make peace with the fact that the kid in your meetings who doesn’t look old enough to ride solo on a roller coaster is not an intern, but an actual employee! Face it, millennials are a force in the American labor force. In fact, by 2020, they’ll represent more than half of all workers in the country. In spite of what you’ve read, those pesky youths can actually teach us experienced folks some important lessons about money, some of which might make you rethink part of your retirement planning. Here are some of the things they’ve figured out that the rest of us might want to consider: