By Dian Hymer
First-time buyers are often caught in a "Catch 22". They usually have the hardest time qualifying for a mortgage. And they have the hardest time accumulating cash for a down payment and closing costs. But they are the buyers who are most often required to pay mortgage insurance, which increases the cost of homeownership and makes qualifying even harder.
Mortgage Insurance (also called Private Mortgage Insurance) is insurance that is paid by the borrower to protect the lender in case the buyers stop paying (default) on the mortgage. The cost of Mortgage Insurance (MI) varies depending on the type of mortgage (fixed- or adjustable-rate), the payment plan and the amount of the cash down payment. It can range from .5 to .95 percent of the loan amount for the first year's premium. The premiums are usually the highest on the riskiest loans, like an adjustable-rate mortgage for 95 percent, or more, of the purchase price. Because MI is insurance and not interest, it's not tax-deductible.
Lenders usually require borrowers to pay for MI if the loan amount exceeds 80 percent of the purchase price. Ninety and 95 percent financing is popular with first-time buyers who often don't have enough cash saved to make larger down payments.
To avoid paying MI, buyers who have a 10 percent down payment get a first mortgage for 80 percent of the purchase price and a second mortgage for 10 percent of the purchase price. This is called 80-10-10 financing. Since the first lender's loan amount doesn't exceed 80 percent, MI isn't required.
Some sellers will carry a 10 percent second for qualified buyers. Seller financing can be less expensive than institutional financing because sellers usually don't charge up-front loan fees. Institutional lenders often charge one point for a second mortgage (1 point equals 1 percent of the mortgage amount).
80-15-5 financing is also available for buyers who only have 5 percent cash to put down on a home. The borrower avoids MI with this financing scheme because the first mortgage lender only loan 80 percent of the purchase price. However, the interest rate charged on a 15 percent second mortgage, with a 5 percent down payment, will be about 10.75 percent in today's market. You can expect to pay about 9 1/8 percent on a 10 percent second mortgage, with a 10 percent down payment.
Be aware that most second mortgages have a balloon payment. A balloon payment is a final payment that's considerably higher than the periodic (usually monthly) payments. Most institutional seconds have payments that are amortized on a 30-year payment schedule. This keeps the monthly payments low and makes it easier for borrowers to qualify. But, these loans are usually due at the end of 15 years, at which time a balloon payment is due.
First Time Tip: Some borrowers are choosing low-down payment mortgages that do require MI payments. This is particularly the case in areas where home prices are rising rapidly.
One San Francisco Bay Area buyer got a good deal on the price of a home. He took out a mortgage for 95 percent of the price to finance the purchase. Prices rose so quickly that the buyer was able to convince the lender to remove MI within 2 years. The lender was willing to do so because an appraisal of the property showed that the mortgage amount equaled 80 percent of the updated market value of the property.
The Closing: Lenders are more flexible about removing MI for buyer's with good credit history than they were in the past.
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