Category Archives: Mailbag

Reader Question: How To Cancel PMI

I recent got an email from a reader of this blog, who asked this question:

Hi Daniel,

My wife and I just found the perfect house, but there’s a problem. We weren’t really planning on moving for another few months, and our down payment fund isn’t as high as we’d like it to be. We know we can save enough money to get us to the 20% mark over the next few months, but we also realize that if we wait until that point to put down an offer, our dream house will almost certainly be gone. Are we crazy to think about taking out a loan with PMI?

-John (not his real name)

With John’s permission – provided I keep his real identity anonymous – I’m going to give my opinion on his situation, and put it to you for some added advice. While Lauren and I are nowhere near buying a house (especially in our area), I’ve started to gain an interest in the housing market.

Today’s housing market is ever-changing; in some places, the recovery is in full swing, in other locations, housing prices and sales are still lagging. We’ve seen record or near-record low interest rates for much of the past year, and although we’d like to believe that rates will stay low indefinitely (word from the Fed suggests they will stay low, likely through at least 2013), there’s always the chance they could start to climb once again. Housing prices, too, could start their ascent. In other words, we can’t expect it to remain a buyer’s market forever. There are some really incredible deals out there, John, and if you think you’ve found one that meets your wants and your needs – and are in the position to afford the monthly payments comfortably – I don’t think it’s out of the question to do that.

But I would add this caveat about PMI (private mortgage insurance). First, aim to have a down payment of at least 10% of the purchase price, so you lock in the lowest tier of mortgage insurance. Next, continue saving after you purchase the property, just like you would if you were still working feverishly to save up for that down payment. Put those extra payments toward the principal of your home loan. Once you reach 22% equity in your home (meaning you’ve paid down the mortgage to 78% of the purchase price), your lender is required under the Homeowner’s Protection Act to automatically cancel your PMI.

There’s a way to shed your PMI even earlier. Once you reach a loan-to-value (LTV) ratio of 80% or less, you can ask your lender to cancel your mortgage insurance. We’re talking LTV here, not a percentage of your loan or the sale price. You may be able to get an instant boost by having your house appraised soon after the purchase; this is a great idea if you’re buying a distressed property at a deep discount (the value is almost definitely going to be higher than what you paid for it). Even if you don’t have your home appraised for a better LTV ratio, making those extra payments until you reach the 20% equity level – then asking your lender to cancel PMI – will help you out immeasurably.

The way I see it, if you snag your dream home right now – and take on PMI in the process – but can put enough toward the principal over the next few months, you may be able to get rid of the mortgage insurance quickly. Say it takes you six months, during which time you’re paying $100 a month in PMI – that’s $600 to get your dream home. It’s not chump change, but if you’re on solid financial footing, it’s also not the end of the world.

Reader, what do you think? Do you think taking on PMI is a horrible idea altogether, or if John plans on paying down his principal – just like he would add to his down payment fund – that canceling the mortgage insurance a few months from now is a viable option?

Mailbag: 5 Steps To Get Out Of Debt

I received this email from “Alan,” a 24 year old who was just hired after being unemployed for 8 months after graduating college.

I am in $15,000 of credit card debt and got a job that pays $60,000/year. I was living with friends without really paying rent and now that I’m moving out into the real world, I have no idea what to expect once I get there. I have to pay for rent, utilities, food, and car payments, I’m not sure how much I should set aside for debt, retirement, and savings. How should I allocate my funds?

Alan seems to be in a fairly similar position to me, although his credit card debt is likely accruing interest at a faster pace than my student loan is. I would recommend 5 steps to get started building savings and tackling the debt.

1. Track Expenses

Go right now and sign up at Mint.com. It’s hard to predict exactly how much you’ll spend on lunch with co-workers, fun, and other expenses. Don’t worry about creating a budget just yet, but be responsible with your purchases. Keep in mind that you’re in debt and are trying to get out.

2. Build $2,000 Emergency Fund

After paying the minimums on your credit card, throw everything else into an emergency fund. Some people suggest that $1,000 is enough to get started, but the truth is that $1,000 may not cover what you need. If something happened to your car or if your job doesn’t work out for some reason, this is what you’ll have to rely on. $2,000 should provide you enough of a cushion at the beginning, and after you have that much, keep contributing a small amount each month to give yourself more to fall back on. Every few months, check back on this emergency financial file and keep adding because as you work more, you’ll have higher expenses and will need a bigger cushion.

3. Build A Budget

Once you have an emergency fund, it’s time to see how much you can afford to throw at the debt. Use Mint to build a budget based on your expenses in the first 2 or 3 months, and cut out what you can. Stick to your budget and you’ll see the debt decrease.

4. Aggressively Pay Off Debt

Anything you have left over after expenses and what you put into the emergency fund, write a check to the credit card company. This number will fluctuate depending your living situation and city you live in, but more you pay now, the less you’ll pay overall. Imagine the feeling of being debt free!

5. Work Hard

While focusing on getting out of debt is great, keep in mind that it will be a slow process. Over time, the mound of debt you have will decrease slowly and surely, but it shouldn’t be all you think about. Focus on your job. Improve yourself, work hard, and get noticed. If the debt is gone but you don’t have a job, then you’ll be right back to where you started. The best thing you can do is to do you job well. Having that job will be much more valuable than the emergency fund.

For now, I am going to suggest passing on the retirement savings because the interest rates on your credit cards are likely higher than the rate of return you’d get in your retirement account. Once you have the debt taken care of, you can start pouring all that money you were using to pa off the debt and instead use it to build a healthy emergency savings account and retirement fund.

What other steps should Alan be taking to get out of debt?

If you have a question you’d like answered, please don’t hesitate to contact me!

Mailbag: What To Teach High School Seniors?

“G” writes in:

I’m planning on trying to teach a short lesson on personal finance to my sister’s high school students (seniors). I’m wondering if you have ideas for an outline of what such a lesson might look like.

I think it’s great that you have the opportunity to educate high school students and I think it would be fantastic if you could do so in an engaging way by talking about topics that they can actually relate to!

At a time when they are ready to head off to college, they are at a perfect age for lessons in personal finance. Remind them that when they get to college, nobody will be there to watch their spending and it will be up to them to decide how to spend their money. I think there are two main topics that are both interesting and important: Planning and Saving.

Obviously those are two very broad topics, so let me break them down a little more to help explain.

Planning

With planning, I’m talking about budgeting. There’s nothing more important than knowing where your money is going, how you’re spending it, and where you need to cut back. Without a plan of how you’re going to spend you’re money, you’ll never be in control of your finances.

Instead of introducing them to software or talking about a budget calculator, I think a good exercise could be naming the important things we spend money on. My guess is that they would include housing, food, and clothes as the most important. But with a limited budget it’s important to note that if they were spending a lot of money on a gorgeous apartment, that would mean less money for shopping.

My suggestion would be to make it fun and give them $1,000 and then ask how they would split it up. The dollar amounts of the different expenses aren’t important, but if everything starts at $250 and increases or decreases, they should be able to understand how increasing in one category means decreasing in another. It’s up to them to find the right balance.

Saving

Compounding interest is one of my favorite personal finance topics and the earlier you take advantage, the more you are able to benefit. I think examples are very important. Start out small and then show how over time, savings continue to grow.

Here’s how I would do it:

First, I’d explain that when your choice is between spending and saving, it’s difficult because you can either get something now or you can get something later. But, if you understand the magic of savings, you find out that by putting money away now, you’ll have much more in the future.

The example could be a showing $100 going toward buying something today versus the saving you put away for 10 years. At 10% interest (to make it simple) that grows to $110 by their Sophomore year or $146 by the time graduation rolls around. They’ll quickly see that while the trade off between having it now and later isn’t appealing to their present situation, they should be reminded that whatever they want now is likely only temporary, but if they put the money away, they’ll have lots of opportunities later and they’ll have more money too!

With all lessons, I think the way it’s taught is more important than the content. If you can’t get through to them, it won’t have any effect. Participation is key, and the best way to do that is to show how this really will affect their lives. Give examples of how you had to use budgeting and these are some of the things you wish you had been taught.

Of course, there are plenty of other topics you could discuss: credit and how to get your credit report, the basics of investing, or student loans, but I think the two outlined above will have the best impact for your audience.

Good luck and let us know how it goes!