Brian is to Mortgages as Bill Gates is to Computers. I suggested my good buddy contact Brian for a mortgage. Brian delivered WAY beyond expectations and spoke to my pal for one hour ON A WEEKEND. Being that Brian has been in the biz for 25+ years, I admire his willingness to help and go Above and Beyond!

James B., Financial Advisor, Washington DC

"No PMI" Loans Are A Gimmick!

June 28th, 2011

Remember in the real estate boom, lenders would commonly make you a loan with a 1st and 2nd trust combined, to avoid PMI? You could put 5% down or 10% down and still avoid PMI. These loans were called 80-10-10, 80-15-5, 75-15-10, even an 80-20 where you got an 80% 1st trust and a 20% 2nd trust, and put no money down! Imagine my surprise when some of these loans started to resurface recently.

My first thought was, "what lenders are stupid enough to lend 2nd trust money these days?!" Lenders lost a lot of money making these loans in the real estate boom, and are still suffering losses from them. When you are a second trust lender, you are in junior lien position, and you will get your money last, if it all, if the loan goes bad you lose most or all your money as a 2nd trust lender. "What fools are making these loans in 2011?" I wondered.

Then I started to take a more thoughtful approach when I realized that some consumers were actually being sucked into these again. Don't get me wrong, back in the real estate boom they were great and were very useful in helping to save clients money. But for a lender to offer these today, in an environment when banks are running away from risk faster than former Congressman Anthony Weiner runs away from a reporter, is astonishing. I realized that there must be some gimmick behind it, and that the lenders that were making these loans were doing it to increase sales, not necessarily help the consumer. And I was right.

Private mortgage insurance is unfortunately a necessity. Without a 20% down payment, you would not get a Conventional loan without PMI. But who likes to spend extra money every month? Isn't PMI a waste? No, not if you want a loan to buy a home. The only alternative would be to do an FHA loan, where the mortgage insurance is anywhere from 2 to 2.5 times as expensive as on a similar Conventional loan. So PMI for people that have less than 20% down payment is a necessity. Or is it?

I had a client who wanted to buy a $558,000 home, and make a 10% down payment. They had gotten a marketing mailer (do people actually open those anymore?) which was advertising a way to put only 10% down and avoid PMI, such as a 75-15-10 loan or an 80-10-10 loan. Below was my reply to the client:

"I finally got all the responses needed to identify the reality of all your choices, and what might be good, and what might be bad. Here are your options using a $558,000 sales price:

option #1
pay the PMI

$558,000 sales price
$502,200 loan a mount
4.625% rate, 30 Year Fixed
$2582/month mortgage payment
$205/month in PMI
$2787/month total (excluding taxes and insurance)
PMI solution: Do a PMI drop in 2-3 years. But, there are lower costs the longer you are in the home due to this PMI drop, versus carrying a permanent high rate 2nd trust. Keep in mind the $2582 month mortgage payment once the PMI is dropped will be the lowest of all three choices.

option #2
75-15-10 (PNC terms of 2nd trust, 20 year fixed rate 6.5%)

$558,000 sales price
$417,000 1st trust, 4.375%, 30 Fixed
$85,200 2nd trust
$2082/month 1st trust
$635/month, 2nd trust
$0/month PMI
$2717/month total (excluding taxes and insurance)
PMI solution: no PMI up front, but higher costs the longer in home.

option #3
90% "single premium" loan, PMI is built into interest rate.

$558,000 sales price
$502,200 loan a mount
4.875% rate, 30 Year Fixed
$2657/month mortgage payment
$0/month in PMI
$2657/month total (excluding taxes and insurance)
PMI solution: no PMI up front, lower monthly costs than all. But PMI drop still potentially lower costs if you are in the house for the long haul.

Check in with any questions, and let me know what you think. As you can see, the differences are not major, and there is no magic bullet to avoiding PMI. And there is actually one option cheaper! Talk to you soon."

My clients ended up taking the loan with PMI, and are confident they'll be doing a "PMI drop" to get rid of PMI in 2-3 years.

In doing my research, I realized the handful of lenders that are now offering these first trust and second trust combo loans, are offering the second trust at a much shorter term, like the above 20 year fixed rate. Some of them are offering the second trust on an interest only basis, which is like putting a giant piece of your house on a credit card where the debt never gets paid down, not to mention that the rate is adjustable and can swing wildly, and might be the most foolish thing I've ever heard of related to buying a home (click here for more on my opinion of "Interest Only" loans).

So the bottom line is that there are no good second trust alternatives to make one of these 80-10-10 loans attractive, to actually make the monthly payment lower. The second trusts offered are not fiscally safe, do not offer a lower monthly payment, and could blow up in the consumer's face. Let's call it what it is, it is a sales gimmick, trickery, a scam, something to increase sales for lenders who are trying to pull one over on the consumer. People reading this blog will not be so easily fooled.

Brian Martucci is a loan officer for 1st Mariner Mortgage, a division of 1st Mariner Bank. He has been in the mortgage industry since 1986 and has served in a number of roles, including loan processor, loan officer, mortgage broker, branch manager, and vice president. His opinions do not necessarily reflect the opinions and beliefs of 1st Mariner Mortgage or 1st Mariner Bank.

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6 Responses to “"No PMI" Loans Are A Gimmick!”

  1. Brian says:

    Why do you omit tax savings from your calculations? Talking to other mortgage-sellers, this seems both commonplace and indefensible.

  2. brianm says:

    Indefensible means, “not justifiable by argument.” Maybe you meant to use the word: curious? Because not discussing the tax break is justified by argument, discussion and fact. I did not use tax breaks in my original discussion because common sense says if the 80-10-10 option is not the best option before tax breaks, and each option will get the benefit of equal percentage tax breaks, then the 80-10-10 also will not be the best option after analyzing tax breaks. In other words, the 80-10-10 does not get to use a higher percentage of tax break than the others. Below is why I can defend not using tax breaks in my original discussion:

    1. We cannot know each blog readers income and tax bracket, so we’d have to assume a tax bracket to calculate the actual tax break. This alone makes discussing tax breaks difficult.
    2. The interest deduction drops every month as interest reduces and principal grows, so the tax break reduces as you pay less interest over time. To the benefit of the person challenging me, I will use the interest payment from the very first payment in the below calculations, which of course comes with the highest interest payment.
    3. PMI can be dropped once you have the loan for at least two years and have 20% equity, but the high interest rates on a 2nd trust cannot be changed.
    4. Tax breaks are uniform across all options and won’t change the conclusion.

    Below are the calculations using some assumptions. I will assume a federal income tax bracket of 28% since I previously used a scenario where a homebuyer who would likely have to make about $125,000 a year to qualify for this hypothetical purchase, and the 2012 tax rate for a single person making between $85,650 to $178,650 is 28%. Here are the previous numbers, revised with the addition of a tax break discussion:

    option #1
    pay the PMI
    $558,000 sales price
    $502,200 loan a mount
    4.625% rate, 30 Year Fixed
    $2582/month mortgage payment
    $205/month in PMI
    $2787/month total (excluding taxes and insurance)
    -542 TAX BREAK
    =2245/month payment after tax breaks are considered

    TAX BREAK CALCULATIONS:
    2582 principal & interest payment = 1935 interest + 647 principal
    1935 is the tax write-off x 28% = 542 tax break

    option #2
    75-15-10 (PNC terms of 2nd trust, 20 year fixed rate 6.5%)
    $558,000 sales price
    $417,000 1st trust, 4.375%, 30 Fixed
    $85,200 2nd trust
    $2082/month 1st trust
    $635/month, 2nd trust
    $0/month PMI
    $2717/month total (excluding taxes and insurance)
    -554 TAX BREAK
    =2,163/month payment after tax breaks are considered

    TAX BREAK CALCULATIONS 1st trust:
    2082 principal & interest payment = 1520 interest + 562 principal
    1520 is the tax write-off x 28% = 425 tax break

    TAX BREAK CALCULATIONS 2nd trust:
    635 principal & interest payment = 461 interest + 174 principal
    461 is the tax write-off x 28% = 129 tax break
    Total tax break = 425 + 129 = 554

    option #3
    90% "single premium" loan, PMI is built into interest rate.
    $558,000 sales price
    $502,200 loan a mount
    4.875% rate, 30 Year Fixed
    $2657/month mortgage payment
    $0/month in PMI
    $2657/month total (excluding taxes and insurance)
    -571 TAX BREAK
    =2086/month payment after tax breaks are considered

    TAX BREAK CALCULATIONS:
    2657 principal & interest payment = 2040 interest + 617 principal
    2040 is the tax write-off x 28% = 571 tax break

    PMI solution: the no PMI up front loan STILL has lower monthly costs than all. And the PMI drop STILL has potentially lower costs if you are in the house for the long haul and you drop the PMI at some point. The “no PMI” gimmick is STILL not the best option. I don’t find my original statement indefensible.

  3. Jason says:

    are you including PMI as a tax break in option#1? the write off for PMI is gone in 2012. if you build the PMI into your loan, you at least get to write off the interest you pay for the life of the loan.

  4. brianm says:

    I am not counting any tax deduction for PMI. And building PMI into the interest rate for the life of the loan, in my opinion, is more expensive; because you will pay a much higher rate for the life of the loan. However, paying PMI for a certain number of years until you can drop it, will be much cheaper.

  5. Jasmin Rathod says:

    Brian,

    Thanks for putting out this article….simple and easy to understand and works great with actual example.
    I'll be in the market (Fairfax county) in couple of months looking to buy a townhouse in the range of 400K….would like to meet and talk about mortgage loans that'll work best for me.

    Thanks

    J Rathod
    jasminrathod@gmail.com

  6. brianm says:

    Hello Jasmin, thanks for the comment. You should go through my pre-approval process when ready, and then we can schedule a meeting or a call and talk details after that. For the pre-approval, go to my website: http://www.getloans.com. Click on the "Pre-Approval" button (not the "Apply" button). There is one simple step which is to simply fill in the form. There is no fee involved. The entire process is safe, secure and encrypted. When you submit it, everything will come straight to my e-mail, and I will get started right away. It should not take more than a few days to finish. Then we will talk about loan programs, down payments, tax breaks, closing costs, etc. Check in with any questions by replying here or directly via email: brian@getloans.com, thank you.

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