When lending money every institution except those who help consumers get easy cash online wants some kind of collateral, which can be used to secure the loan and claimed or even liquidated in case the customer fails to pay the taken money back.
Properties are usually secured by “equity”, which is the margin between the loan amount and the property value. If a 50000 USD loan is secured by a 100000 USD house, for instance, there is plenty of equity and the lender has enough security. The house can be claimed in a foreclosure if the monthly payment does not come in.
If the equity is not so substantial, the lender has certain problems. Sometimes the house taken in foreclosure does not match the sum owed on the mortgage, and then the lender has to bear costs connected with juridical procedures, owing home for a while and broker’s fee to resell the house.
There is a solution to all this, its PMI – Private Mortgage Insurance. As a rule if the amount of a loan is more than 80 percent of the house value, the customer has to insure his ability to make payments. In case he fails to pay the insurer will pay it off for the client.
PMI used to be required on the part of the buyers, who did not have 20 percent to put down. There is a certain formula to determine the rates: it’s loan amount multiplied by 0.005. Therefore $80,000 balance requires annual $400 PMI, divided into monthly payments of $33.
As 20 percent of home sale price is rather a big sum of money, most customers in real estate market need PMI. But if the principle balance drops below 80 percent of the house value, the lender is obliged to inform the clients and cancel the requirement of Private Mortgage Insurance. Usually it happens in several years after the deal.
In the past decade the lending companies helped the borrowers to avoid the PMI requirement, because the lending standards were of loser model. The customers who lacked a 20 percent payment were allowed to apply for a “second” loan to make up the difference.
A homebuyer with a 10 percent down payment could, for example, take a loan for 80 percent of the house price and another one for 10 percent, which he lacks. The loan for the 10 percent has higher interest rate as it’s more risky for the lender, because he is in junior position to the first lender who is able to foreclose the house. In such a pattern there is no PMI, and the buyer has the advantage of tax deductible interest rate on the second loan, in contrast to PMI.
There was one more option in earlier days: on the condition you pay 0.75-1 percent more interest on your first-position note the lenders agreed to waive the PMI requirement. Such condition may seem attractive, but if to look at it carefully, you may notice that there is a possibility to stick in a 10-year time warp.
However financial tricks have gone to the past and nowadays very few lenders have much cash to put into second-position loans.