It turns out this is actually a pretty simple formula. The cost is a percentage of the loan amount. That percentage depends on what percentage the mortgage is of the home value.

• For a 30 year fixed loan
  • 80% < mortgage <= 85% of home value, PMI is 0.32% of mortgage amount, annually
  • 85% < mortgage <= 90% of home value, PMI is 0.58% of mortgage amount, annually
  • 90% < mortgage <= 95% of home value, PMI is 0.78% of mortgage amount, annually

• For a 15 year fixed loan
  • 80% < mortgage <= 85% of home value, PMI is 0.26% of mortgage amount, annually
  • 85% < mortgage <= 90% of home value, PMI is 0.46% of mortgage amount, annually
  • 90% < mortgage <= 95% of home value, PMI is 0.72% of mortgage amount, annually

• For a 30 year adjustable loan
  • 80% < mortgage <= 85% of home value, PMI is 0.37% of mortgage amount, annually
  • 85% < mortgage <= 90% of home value, PMI is 0.63% of mortgage amount, annually
  • 90% < mortgage <= 95% of home value, PMI is 0.92% of mortgage amount, annually

I initially came across this breakdown here, and I have confirmed its accuracy via my own good faith estimates (GFE’s).

Some brief background information that I picked up from asking my lender. PMI rates are controlled by the federal government. There are only a handful (3?) of PMI companies even out there. But because the rates are set by the government, you don’t have to worry about who your PMI company is (and you certainly don’t have to choose one — the bank does). In fact, when I asked my lender who my PMI company would be, he said he didn’t even honestly know (because it doesn’t really matter).

Like me, you probably see PMI as “lost” money. It doesn’t pay down your mortgage — you just need to pay for the opportunity to buy a more expensive house. Therefore, PMI payments should be minimized. You’ll notice the percentage of the mortgage that your PMI payments are is higher if you put less down (and this makes sense). Therefore, these numbers might give you more incentive to put more money down (minimize your PMI payment).

For example, initially my girl friend and I intended to put 5% down. Our sale price is roughly $420k. So the down payment would be $21k. The remaining $399k would be financed. Using the standard mortgage approach, this would result in a PMI payment of $399,000*0.78% =$3112 annually. Or, $259.35 monthly. That’s a lot of “lost” money per month! Therefore, we actually decided to stretch a bit and put down 10%. Hence, we’ll put down $42k (significantly more), and finance $378k. Our PMI payment would be $378,000*0.58% =$2314 annually. Or, $192.85 monthly. This number is partially lower because the amount financed is lower ($379k vs. $399k), but it is mostly lower because the PMI percentage factor is significantly lower (0.58% vs 0.78%). Ultimately, this results in roughly $70 a month less of “lost money.”

Chances are you are going to put down what you can afford (for us, that extra $21k had to come from somewhere!), but hopefully this gives you a bit better understanding of the impacts of putting more or less money down.

In the end, my girl friend and I are planning on putting 10% but going with a lender paid PMI option, so the above analysis does not directly apply. However, the additional interest rate hit you take when going to a lender paid PMI option is also a function of what percentage you put down, hence we still chose to put down 10%.

We are very excited but also nervous. It’s a huge investment! The whole experience was about as expected. It had plenty of up’s and down’s, and the overall stress level was high. There were days when I wanted to go into work just to get away from it all. I always knew the end would justify the journey, but getting through it all was still difficult — especially since we are first time home buyers.

Ironically, we ended up buying in a new development that I had mentioned in an earlier post. Initially, we felt that Harbour Pointe would be out of our price range (initially about $350k). However, after seeing approximately 10 places in Locust Point, we came to realize that you just don’t get a lot of bang for the buck for $350k. The homes were okay, but they didn’t impress us.  And when you’re making a investment of several hundred thousand dollars, you really want more than “it’s okay.”

Comparing Harbour Pointe to the re-sales on the market, it seemed that for an additional 15% ($50k), you literally got twice the house. We re-ran our numbers and decided we could stretch a little and afford Harbour Pointe.

To recap the points I made the previous post, for an extra $50k, you go from a 12 ft wide row home to a 20 ft wide town home. You also get a 2 car garage (which is pretty much unheard of in the city). City parking honestly sucks, so parking is a huge perk. Older homes (rehabs and resales) usually don’t have parking because the lot is so old (100 years) that homes weren’t spec’ed out for cars back then. Lastly, while many re-sales are rehabbed, clearly new construction is less risky in terms of maintenance, etc. To further support the value of these new homes, I’ll quote the sales numbers.  They have sold 6 of the 9 units in the current phase in only 8 weeks. 2 of 3 remaining are end units (always harder to sell). To sell that many so quickly in such a down real estate market really says a lot about the price point of the project.

Anyway, my initial intention was to blog throughout my home buying process as a sort of diary, but I quickly got too busy.  However, there is not to say I didn’t get many “lessons learned” which I plan to share over the next few weeks. This will include budgeting, buyer agents, choosing a lender, choosing a loan, security systems, and much more! Stay tuned.

Tax deductibility allows you to reduce your taxable income by the amount you pay for PMI in that year. Hence, this can effectively save you ~25% (or whatever your tax bracket is) on your PMI. If you pay $200 a month in PMI, that’s a cool savings of $50 a month.

The criteria for PMI tax deductibility are as follows:

• Mortgage must have originated on or after Jan. 1st, 2007 (yes, refi’s count!)
• Your Adjusted Gross Income prior to deductions must be less than $100k. Each $1k there after reduces the tax deductibility by 10% (completely phased out at $110k)
• The property must be a primary residence

The tax deductibility of PMI should play a very large role in your decision between picking 80%+ loan options. A borrower-paid PMI scheme can offer many advantages over lender-paid PMI or piggyback loans. PMI tax deductibility will make that borrower-paid PMI option that much more attractive!

Now a brief history of PMI deductibility. Before 2007, PMI was not tax deductible. Also, piggyback loans were nowhere near as common as now. Borrower-paid PMI was the usual option when dealing with 80%+ financing. But with the recent housing boom and all the creative mortgage options that came with it, piggyback loans become more and more popular. Also recall that 80%+ financing was also becoming much more prevalent during the housing boom. In fact, one could argue it was a major cause of the boom, as it opened the housing market to a larger population. To answer this move away from PMI loans (choosing piggybacks instead), it was suggested PMI become tax deductible.

Law makers first passed this into law in 2007. To law makers this was yet another way to help youngsters afford homes (hence the cap on annual income). However, the law in 2007 was quite limited. PMI was only deductible for mortgages that closed in 2007, and the PMI would only be deductible in 2007. The law was set to expire at the end of the year.

Luckily, law makers have extended the law through 2010. What happens after that? We’ll have to wait and see!

Google the topic to get more information. I found this site and this site particularly useful.

First off, these options only exist because I am not putting at least 20% down. Afterall, who can afford that? So because I am not putting 20% down, the lender needs something else to assume this higher risk. One form of that is private mortgage insurance (PMI). Exactly as it sounds, this is an insurance policy so that if I default on my mortgage, the lender (the bank) will still get money (from this insurance company). PMI comes in two flavors — borrower paid (me) or lender paid (the bank). But don’t worry, the bank will get it out of you one way or another! The third option which avoids PMI is a piggyback loan situation. This situation actually creates two loans, such that the primary loan is no more than 80% of the home’s value (hence avoiding PMI). But, of course, the second (piggyback) loan will be at a higher rate since it does not have first dibs (lien) on the house if I default.

• Borrower Paid PMI: Borrower paid PMI is probably the simplest option to understand. Say I put down 10% on a home, my mortgage will cover 90% of the home value. Being more than 80%, PMI is required. Borrower paid PMI means that I pay a monthly premium (usually around one or two hundreds dollars) in addition to my monthly house payments. If you use an escrow account, this PMI payment would be folded into the escrow. PMI is expensive and no one is ever happy to pay for someone else’s (the bank’s!) insurance. However, there is an advantage. The good thing about borrower paid PMI is that once your loan is no longer greater than 80% of the home’s value, you can drop the PMI payment! This can happen if your home appreciates enough or if you pay down enough of the principle. Note, if you try to cancel PMI because your home has appreciated, you’ll need a reappraisal which may cost several hundred dollars. Of the three options here, this is usually the most expensive in terms of monthly payments initially, but since you get to eventually drop the PMI, the total cost over the life of the mortgage may be the cheapest.
• Lender Paid PMI: Another way to finance PMI is to have the lender pay it! Sounds great, right? Well, it comes at a cost. The lender will charge you a higher rate on your mortgage to do this — maybe around 0.25% or 0.5% higher. So, you as the borrower completely avoid ever having to deal with PMI, but your entire mortgage will be at a higher rate. From my minor experience, I’ve found this results in cheaper monthly payments than borrow paid PMI, however, you can never “cancel” the higher rate even if your mortgage eventually becomes less than 80% of the value of the home. That higher rate is fixed for the life of the loan! Hence, while the initial monthly payments are cheaper than borrow paid PMI, they will eventually be higher when the borrower paid PMI would have been cancellable. The glaring question is… assuming you can afford the higher monthly payments initially, how long does it take until you can cancel the borrow paid PMI? Unfortunately, you’re going to have to run the numbers yourself to answer this one, as it depends on how much you pay each month and the appreciation of the home. A rough calculation using dinkytown’s calculator shows it maybe around 6 or 7 years (though this is highly situationally dependent).
• Piggyback Loan: The last option is called the piggyback loan. Here, there is a primary loan that is 80% of the value of the home. This is the standard loan. The, a second loan is created to assume the rest of the debt. This is called the piggyback loan. It can commonly be in the form of a home equity loan (HEL) or a home equity line of credit (HELOC). This secondary loan is constructed such that in the case of a default, the primary loan has first rights (first lien) on the property. Therefore, the piggyback loan is much higher risk, which translates directly to a higher interest rate for the borrower. This rate maybe around 2% higher than the primary loan. This higher interest rate makes that second loan costly, but the good news is you can focus extra housing payments directly on that loan and pay it down faster. Also, usually interest on the piggyback loan is tax deductible, where as PMI may or may not be. My minor experience has shown that the piggyback loan monthly payments fall somewhere between the borrow paid and lender paid PMI options.

To summarize, there are three different ways to finance mortgages higher than 80% of the value of a home, each with their own twists. Of course, you really need to run your own situation to find out exactly which one is best for you! Your credit score, down payment amount, income, and tax bracket will all affect the results. Also, the tax deductibility (a future post to come this week) of PMI affects this greatly too. But probably most importantly, the time line of how long you may keep the home (more specifically, the mortgage) affects the decision. Remember that refinancing is always an option, though it is not cheap and interest rates will undoubtedly change (up or down, who knows!). Of course, your budget my dictate which option to take, as the monthly payments associated with each is different. So as with anything else financial, it is important to run your own numbers and analyze your own particular situation. And don’t worry, your mortgage lender should be there help you through the process. Hopefully this post gives you the right questions to ask!

The down payment question is a big barrier for younger buyers. Plenty of young adults make enough money to comfortably pay a mortgage, but simply don’t have the thousands saved up for the down payment. The amounts necessary can seem too daunting, so people give up on saving before they even start. Say you need $50k. Even saving $250 a month, this would take over 16 years!

This brings up the all important question of how much you really do need for a down payment. Convention says 20%. During the housing boom, sometimes you didn’t even have to cover closing! And now, during the Credit Crunch? Going through the process right now myself, I am happy to report that with good credit, you still don’t need the 20%. From the mortgage brokers I’ve spoken to, 5% seems to be the minimum. 10% is the strongly desired. 20% seemed only necessary to avoid mortgage insurance and/or piggyback loans. However (and this is where the Credit Crunch gets you), the trick is that you really need good credit. Supposedly, while the Credit Crunch hasn’t affected those with good credit, it really has put the brakes on those with less than perfect credit.

So assuming you have less than perfect credit or that you don’t even have the 5% saved up, what are your options?

1. Save: Sorry, I know this is terribly obvious, but it is also terribly important. While it might take a while, start saving a few hundred away each month if you can. Depending on your time line, you may even be able to invest this in stocks. Set your online bank to take an extra bite of your pay check every month. This is actually also a really good way to “test drive” a mortgage. Assuming a mortgage would be more than your rent, force yourself to save the difference between the two. This will give you a sense of what living with that mortgage would be like.
2. Pull Out Some from Your Roth IRA: One of the little appreciated facts of Roth IRAs is that you can pull contributions out at anytime with no penalty! So if you have thousands saved there, you might be able to tap that resource. However, funding your down payment with your retirement comes at a huge cost. You can never make up those years’ worth of contributions. Ideally, you would never tap into your retirement early, but your finances are a balancing act. If you find yourself “heavy” on retirement and “light” on a down payment, the option is there. Another strategy I actually used for about 6 months was to increase my 401K contribution and use your Roth IRA as a down payment savings vehicle. This assumes you aren’t already maxing out your retirement (I’m not so lucky). The advantage is that your down payment money (in your Roth) grows tax free. The tax free compounding can help a lot long term. Then, you pull out your contributions when you need it. All things being said and done, I will not be pulling out of my Roth IRA for my down payment mostly because the market has tanked in the last six months.
3. 401K Loan: This option is fairly similar to pulling money out of your Roth IRA, with a few twists. For one, to avoid penalties the money would come in the form of a loan. You have to pay it back. And, you have to pay interest! Luckily, the interest is credited to your own account. Unfortunately, you will be doubled dipped on taxes in the exchange. You will pay taxes on the loan when you take it, and you also have to pay the loan back with post-tax dollars. This is the killer that makes this option less desirable.
4. Gift: Last but not least, you can always beg Mom and Dad for help! This is becoming more and more common these days as it is becoming harder for young home buyers to come up with their down payments. If you are lucky enough to be in this situation, first and foremost thank your parents for the generous gift! Second, understand the gift tax laws. $12k per calender year may be given tax free as a gift. If a parent wanted to gift you more, I would suggest splitting the gift up between calender years to avoid taxes. After all, your parents want to give you the money, not Uncle Sam!

Getting a down payment together is hard! Inflated housing prices across our country doesn’t help either! The good news is, with good credit, you don’t need 20% down. The bad news is even 5% plus closing costs is easily tens of thousands of dollars! So ultimately, how have I come up with my down payment? Honestly — good ol’ savings. I kept my head down for a few years and the money slowly grew. I also happened to hit good timing in the market (pulled out at end of last Summer!), which helped. I had originally planned on using some Roth IRA funds (while up’ing my 401K to reach my monthly retirement goal), but with the down turn of the market, selling is the last thing I want to do with my IRA! So, in the end, it came down to savings. Sort of anti-climatic, no?

I will use Baltimore (my home) as the primary example, but my argument could work for many real estate markets out there. The above linked CNN article says Baltimore housing should drop 27.8% over the next five years because the current price to rent ratio is 20.7, where as the 15 year average is 12.6. What exactly is the price to rent ratio? This number is simply the cost of a home divided by the yearly rent for such a home. Hence for Baltimore, if the average home were $250k (a reasonable guess), the rent would be ~$1000 monthly (that is, $250,000 / 20.7 / 12 for monthly).

Assuming price to rent ratio is a mean reverting value, this means one of two things: (1) homes will significantly drop in price or (2) rent prices will sky rocket until the historical average P/R is met. In reality, it will be both effects. The article does assume a modest increase in rent, but to mean revert, the article predicts that housing will still fall a staggering 27%.

Before I make my point, look at these numbers of different P/R for different cities throughout the country. Notice something obvious — different cities can have very different historical P/R ratios. Los Angeles is 16.0, San Diego is 22.4, New York is 11.7, Raleigh is 19.4. P/R’s are different because these are different cities (duh).

What this tells me is that when cities change, so can their P/R ratios. And cities are changing all the time. While I can’t speak for other cities out there, I can very confidently say that Baltimore has changed dramatically in the last 10 years. Many of the higher paying DC jobs have moved north toward Baltimore. The city has physically transformed from the inside out from a poor, crime-infested city to one booming with a revitalized downtown and always-crowded convention center. Is it so inconceivable that the P/R ratio might change also?

Here’s the ironic part. Baltimore’s P/R will still be mean reverting! However, this could be because the 15 year average moves more towards to the current P/R, not because the current P/R moves toward the old 15 year average P/R. For example, say the P/R says at the new P/R level for the next 15 years. Well, in 15 years the 15 year average P/R will be dead on! This is obviously a self-fulfilling prophecy, but that’s the whole point!

In conclusion, I do believe many housing markets (including Baltimore) are over priced. However, I doubt the accuracy of the P/R ratio analysis when calculating exactly how far these places have to far.  I believe -27% is just another example of sensationalizing the news. This analysis does not leave room for transitioning cities which many cities in America are currently doing. Also, I question using the 15 year average P/R since given enough years to adjust, this is only a self fulfilling prophecy.

Perhaps I started getting worried when I emailed him at work right away and never ever heard back. I called my insurance right away and called his insurance too. I got my estimates, etc. When I call his insurance a week later, they say my version of the story doesn’t match his and that they weren’t going to accept viability. Yep, I’m pretty much seething at this point.

I call my insurance (Geico) and explain the story. Now I’m really kicking myself for not getting a police report. However, I was smart enough to do one thing. While we were exchanging insurance information right after the accident, I snapped a few shots with my cell phone camera. The shots clearly showed how our cars were positioned after the collision. The car positioning made it very clear that he made a left in front of me (which he didn’t admit). Ultimately, this was my saving grace, and Geico called me just last week to tell me his insurance had finally accepted liability and I would be getting my deductible back. Phew.

Lessons learned:

1. I don’t care who it is — if you’re in an accident and you are convinced its not your fault, call the police. Get a report. Usually it’s the only evidence you will have for the insurance companies to battle it out.
2. Thank God for my cell phone camera! In general, I think cell phone cameras are pointless, but here it saved me $500. So take a few shots if you get in an accident. Get pictures of the damage and the positions of the cars and environment.
3. If you have witnesses, use them! I didn’t in this case, but insurance explained to me that without witnesses, police reports are the only form of evidence (besides my handy cell phone shots!).
4. Insurance companies are a business (duh) and don’t care about you at all. But instead of taking that comment negatively, try to take it your advantage. Geico preferred not to be involved and that I just go through his insurance. It wasn’t until after his insurance denied me damages that I got them involved.

Overall, when all is said and done, I am happy with the outcome of this. I was afraid I would be out $500 simply because this guy lied (or at least twisted the truth, which his insurance then creatively interpreted). But I made that all harder on myself by not calling the police right away. And ultimately, while I’m happy because I didn’t loose my $500, the whole affair was nothing but a headache. Car accidents suck. Period. So drive carefully!

The long term effect of Fed rate cuts is to drive the mortgage rates down. When rates are cut, this allows banks to borrow from each other and the Federal government at a lower rate. Hence, banks can offer loans at a lower rate and still make the same profit. Due to bank competition, this is exactly what happens.

However, the short term effect of Fed rate cuts can have just the opposite consequence! Check out this chart from Bankrate of the national average 30-year fixed rate mortgage rates of the last few months.

You can clearly see the mortgage rates drop, but then slightly rise back up recently (the rate cuts!). Here’s what’s happening. The Fed’s cut the rates to stimulate the economy. That is, they wanted to help companies and also soothe investor confidence. Make no mistake, the emergency rate cut of two weeks ago was partly a response to the stock market’s recent nose diving. And the rate cut has helped the stock market (the Dow is up roughly 4.8% in the last 10 days). But with investors reinvesting in the stock market, that means they aren’t investing in bonds (the usual coupled relationship between stocks and bonds). So in response, bonds must offer a higher yield to compete with the stock market and get investors. Of course, bonds are nothing more but repackaged loans sold off as investments. Therefore, the loans that make up these bonds must be at a higher rate. And there you have it. The immediate short term effect of Fed rate cuts actually increases mortgage rates!

A day or two after I had read this in the above linked article, I actually spoke to my mortgage broker (I’ve been getting pre-qual’ed) about it too.  He reiterated the short term effects, and even suggested following the 10 year T-Bill for a more accurate tracker of mortgage rates.

Filling out the online Lending Tree application was pretty simple, and took about 15 minutes. I was feeling good (a small step, but progress) and ready for banks to fight over me (!). A brief Lending Tree intro. Lending Tree acts as the middle man between banks within their network and you. They talk to all the banks for you and get you the best deal. They hold your hand through the whole process. There is another slightly less convenient avenue they offer too called their Get Smart service. If they can’t get 5 in-network bank offers for you, they will (at your request) send all your information to other mortgage brokers who will contact you directly. Back to the story…

Immediately after submitting, Lending Tree pops up a window saying the following banks are already competing — Yes! Except… there was only one bank listed. Hmm. I thought that was odd, but whatever. I’ll just wait for my courtesy phone call like Jim got!

Hours pass. Nothing. I check my email. There is an email from Get Smart saying my information had be passed on to two other brokers. Okay, works for me. Over the next two days, I talk to both brokers and I’m happy to say I got all the pre-qual letters I need (for now at least). But I never heard from Lending Tree…

Eventually today I receive an email directly from Lending Tree with the offers from all my competing banks (yep, all ONE of them). At this point, I already have my pre-qual letters so I’m set. But I’m still curious about why I only got one bank directly through Lending Tree.

Still bitter about not getting my personal welcome phone call like Jim, I call Lending Tree up. The lady was very nice, helpful and professional. I basically asked why I only got one offer. She goes over my information. Everything was correct — excellent credit, money down, amount desired. So what gives?

Not sure herself, she suggested perhaps I was asking too much for the property type I’m interested in ($400k, town home). Eh, I don’t know if I buy it, but I knew $400k was more than I really wanted to spend anyway. So I have her resubmit my application asking for $350k. This is significantly less money which means my down payment ($40k) is a larger percentage, montly payments will be a smaller fraction of my income, etc.

But once again, I check my email and exactly ONE bank is competing for me (not even the same bank!)! Huh?!? And… where’s my courtesy phone call?!?!

Here’s my theory. When Jim purchased, housing was hot (Spring 2005, I think). Mortgages were flying all over. Lending Tree probably had a lot of business and had to keep things moving quickly to maximize profit. Fast forward to Early 2008. Housing is bursting. Credit is crunching. Lending is hard to come by, and the industry is cautious if not down right scared. And while I am a very desirable mortgage customer, I don’t have 20% down (I have about 10%). I think this must be key because Jim recently looked to recently looked to refinance through Lending Tree and once again got lots of offers immediately.

So banks aren’t exactly competing for me (not through Lending Tree at least), but I’m happy to say I didn’t “lose.” With my pre-qual letters in hand, I am ready to continue the slow, cautious process of looking for a home. In fact, my girl friend and I have an appointment with a realtor tonight.

A little history. Baltimore is full of old row homes, not uncommonly 100 years old. Many people made fortunes during the housing boom by buying up these old row homes, fixing them up, and selling them at a handsome profit. One unique feature due to the old age of row homes is the fact that they are usually only about 14 ft wide! If you haven’t seen one before, this might sound ridiculous. And it kinda is! But 100 years ago, that’s how things were (my Dad — an architect — thinks that was probably the standard length of wood lumber back then, hence is became the standard). And while rehabbing a home can make it beautiful inside, you can never widen the home unless you buy the adjacent property and start from scratch. With that in mind…

One owner bought this house at the end of ‘05 for $230k. She proceeded to rehab the home for about $200k (according to her). She thought the home would easily be worth $550k now. Unfortunately for her, the bubble is bursting, and she’s now listed the place for $380k. Note, this is already $50k under the money she’s put in it! But the house has been on the market for a good year now, and according to her, she’s only gotten a few low ball offers.

Instead of telling you I think $380k is over-priced, let me show you what everyone else looking for homes in Locust Point is seeing. Just up the street, welcome to beautiful Harbour Pointe! Here’s a brand new community of town homes starting at $400k. For $20k more than the Lowman St property, you get the following:

• 20 ft wide home instead of 14 ft wide: As someone very familiar with town homes and row homes, this difference is HUGE. The rooms feel like rooms, and not shoe boxes! Not only will the square footage be much higher, but the aspect ratios of the rooms are better too.
• 2 car garage: We’re talking about city living here, people. Parking is huge. Two spots is even bigger. Two covered spots with extra storage is…! You get the picture.
• Brand New: Did I mention it’s brand new? While the Lowman home is a full rehab, you never quite know what’s still 100 years old in your “full” rehab!

I will concede that the Lowman property was redone absolutely beautifully. The material and design is more luxurious than Harbour Pointe. However, I question if anyone wants to spend that much money on that nice a place and live in 11 ft wide rooms (14 ft is outside the walls). And finally, the owner is not a real flipper. She had every intention to live in this place, but her job changed. This effectively makes her situation the same as that of a flipper, though unintentionally so.

So what is our owner to do? She’s losing $6k a month in payments, but every dollar she drops that price from $380k is another dollar lost on top of $50k already. Tough situation. Anyway, looking for a home myself, I’ll keep my eyes open to see what happens.