In the Author's Corner: Marc Eisenson
"Nightmare on Elm Street"
|Marc Eisenson is the author of The Banker's Secret, the book which tells you everything you ever wanted to know about prepaying your mortgage. The following article is reprinted with permission from his quarterly newsletter, "The Pocket Change Investor."
If someone offered you a $12,500 loan at 26%, would you go for it ... or call the cops? Millions of homeowners have already signed on for this kind of loan -- which is offered by private and government lenders -- not your usual loan sharks. It's strictly legit, from sea to shining sea.
Here's the deal: You scrimp and save enough to make a down payment, then go out with a real estate broker. The first home you see is ok, not great. The second's no better. The third, over on Elm Street, is a dream. Unfortunately, it's also a budget buster -- $125,000 is as low as they'll go. You couldn't possibly come up with enough cash. "No problem," says the commission-hungry broker, "I'll help you get a loan where you'll only have to put down 5% or 10%. Trust me."
Bankers know that the smaller the down payment, the larger the likelihood of default. So they require "protection money" whenever the down payment is less than 20%. Borrowers protect lenders by paying for private mortgage insurance (PMI), or the FHA's equivalent, known as MIP.
Take that $125,000 dream house on Elm. Come up with 20% ($25,000), plus another 5% or so for closing costs and escrow, and you'd get a $100,000 no-point loan at 7.75%. No PMI, MIP, or other alphabet soup acronym required.
But come up short, and boy will it cost you. For example, buy that house with only $12,500, or 10% down, and you'll pay $3,326.68 for PMI (more or less), which is a staggering 26% of the $12,500 in up-front cash that you didn't have.
Add in the 7.75% in bank interest, and it's up to nearly 34%, which is way more than even the greediest credit card companies charged in their hey day. You'll pay $23,320.74 in premiums and interest on that $12,500.
And these numbers are based on an optimistic PMI scenario. Your costs could easily be thousands of dollars higher. In fact, an FHA-guaranteed loan is guaranteed to cost you more, about $2,400 more.
As you might expect, the less you put down, the more you'll pay. Putting 5% down on the Elm Street house ($6,250), could mean more than $35,000 in premiums and interest.
Don't Do It!
I know these mortgage insurance programs are extolled as a way to bring the American dream to poorer families. But, as always, the poorer you are, the more you'll pay. Avoid PMI and MIP. You have alternatives:
- Rent. It can be a far better value. (See Bulletin #5.)
- Save, save, save, until you have 20% to put down.
- Buy a less expensive house.
- Rent with an option to buy.
- Ask the seller to carry the mortgage.
- Buy the house in partnership with a parent or friend.
- Be creative. The future you save may be your own!
But If You Can't Resist ...
Understand what you're getting into. It's confusing, but here's the gist: You'll pay PMI until your home equity is 20% or 25%. Whoever owns your mortgage, at that time, gets to decide which, and whether you'll need to pay for one or more appraisals, before they'll consider setting you free.
With 10% down, it'll take 9 years to build up 20% equity on Elm Street. Mortgage pre-payments of $50 a month would get you to 20%, 2.5 years faster, saving you $39,889 in interest and PMI premiums over the loan's life.
There's another way your home equity can increase. If you're lucky, property values will go up. (Don't count on it.)
As your equity approaches 20%, or whatever your lender requires (good luck finding out!), get on the case. It's extraordinarily unlikely that you'll get a call saying, "We don't need any more protection. Feel free to cancel PMI."
A Sliver of a Silver Lining
Barbara Walker, one of our readers, found out she was eligible for a partial MIP refund, after her house sold. Her lender sent in an application to HUD, then she persisted. A year later, the sleepy bureaucracy issued her an $850 check.
To inquire about FHA refunds, and to do some persisting of your own, call HUD at 800-697-6967. But be forewarned. The wait can be interminable.
PMI refunds, after an early sale or pay off, are also possible, if you buy a refundable policy. If you think you'll only keep the house for a few years, ask for a monthly premium policy.
The Banker's Secret is a best-selling handbook which shows exactly how to save thousands, by using your "pocket change" to pay off your debts. It shows you how to double check the bank's numbers, and answers all your pre-payment questions. For example: Will I lose my tax deductions? What about pre-payment penalties? Should I have my loan converted to a bi-weekly? (No!) Also includes 160 exclusive money saving tables that show you how much money you'll save on your loans.
The Pocket Change Investor, begun in 1990, is quarterly newsletter published by Marc Eisenson and Nancy Castleman. Each issue focuses on something that costs you and your family a lot of money. Let this team of consumer advocates show you how easy it is to profit from your debts, how to finance your child's education, when to rent ... or buy, and how to teach your youngsters to manage their money.
Learn painless ways to save on taxes, credit cards, closing costs, cars, insurance, appliances, utilites, vacations, trips to the supermarket, and the myriad of other expenses that regularly confront us all. It's worth far more than the $12.95 annual subscription rate. (Don't tell them, or they may raise the price!)
To subscribe to The Pocket Change Investor ($12.95 for 1 year, $19.95 for 2) or to get a copy of The Banker's Secret book ($17.95, includes s/h), call 800-255-0899 or fax 914-758-1475 with credit card info. You can send a check for the newsletter and/or book to: Good Advice Press, Box 78, Elizaville, NY 12523.