Friday, June 13, 2008

Mortgage Scam

I will NOT name lenders here (since they all do this) but I am sooooo ticked about the latest mortgage scam that we have discovered: PMI. Yeah, it's that silly extra insurance that you have to pay each month if you put down less than 20% of the home's cost at closing. For the most part, that makes sense to me and it's a simple math problem to figure out. Say for instance that you are buying a house for $200,000; 20% of that is $40,000 so at closing you would need to shell out about $48,000 ($40K down plus $8K closing costs) to avoid paying PMI. If you only put down 10% at close ($20,000) PMI would be about $80 a month until your principal amount is down to 80% of the cost of the house.

Here's the first scam:
When purchasing the house for $200,000; if the house is appraised by the mortgage company for, oh say $275,000 then THAT'S the amount that the mortgage company will force you to insure the house for. This can result in an increase in your annual insurance payment of up to $1,000 which increases your escrow payment by $100 a month. I know that equals $1,200 but mortgage companies like to have an escrow 'cushion' of at least 2 month's payments at the lowest balance. So here, the mortgage company is earning interest on your escrow payments (which are based on the inflated amount that your home is insured for) for the whole year.

And here's the second scam - the part that really makes me mad:
When the mortgage company determines your loan-to-value ratio (LTV), which has to be at 80% or below before you don't have to pay PMI anymore, they divide the current principal balance by the appraised value of the property at the time the loan was closed or by the contract sales price, WHICHEVER IS LOWER. So even though they make you insure the house for appraised value of $275,000 instead of the purchase price of $200,000 , they TOTALLY ignore that appraised value when it comes to figuring the home owner's equity in the house to get rid of the PMI.

So, not only are they earning interest on an extra $100 a month that you have to pay for the home owner's insurance, they are making another $80 a month for PMI. Because, of course, the PMI is being purchased, on your behalf, from one of their subsidiaries. And you have to pay the PMI for 7 to 10 years or possibly longer. So that's an extra $2,000 a year that you are paying the mortgage company for 10 years. The PMI costs you almost $10,000 , and that's money you'll never see again. But most people look at from the monthly standpoint and $80 a month isn't so bad - it's a date night, or one concert ticket.

Reminder: DO NOT look at that piece of paper in your closing paperwork that states how much interest you are going to pay over the life of the loan! Yes, you could buy a whole other house with that money that you pay to borrow the money.
Think about that same $200,000 house with 10% down, a 30 year, fixed rate mortgage at 6.5%: you're monthly payment will consist of Principal + Interest of $1200.93 (those first 2 years of payments have less than $200 going towards principal and over $1,000 going to interest) PLUS your escrow payment of about $500 a month for insurance and property tax PLUS the PMI for 10 years so each month you are paying the mortgage company about $1,800 each month. For the other 20 years you'll probably pay the same or more, allowing for increases in your insurance rates and property taxes. So at the end of 30 years you'll have paid about $650,000 for your house. Now granted, $216,000 of that was for taxes and home owner's insurance; but the P&I total is $432,334! Yep, over 30 years you'll pay $242,334 IN INTEREST for that house.

The moral of all of this?
Buy as affordable of a house as possible (could you afford the monthly payment on just one income?). Put as much down on your house as you possibly can. When you have extra money, make extra PRINCIPAL payments instead of buying a new car or vacation or TV or bicycle or purse or boots!

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