expense
Federal rent relief is coming. Here’s what to expect in California
The new stimulus bill passed by Congress includes $25 billion in rental relief for struggling tenants, $2.6 billion of which is coming to California. Can I apply?
Should You Pay Down PMI or High-Interest Debt First?
Money Girl listener Danielle M. says:
I’ve been listening to your podcast for about five years now since I graduated from college. I greatly appreciate the tips and guidance you give to the community as a whole. Thank you for giving me the confidence and knowledge to build a solid financial foundation.
I recently purchased a home, which includes a PMI payment. I also have student loans and a small car loan. We have extra money every month to put toward our loans. I understand it’s best to pay down debt in order of the highest interest rate first. I’m wondering how to evaluate my mortgage since the interest rate doesn’t include PMI payments. Should I pay down my mortgage until the PMI is gone, or is it better to focus on my higher-rate student loans first?
Thanks for your great question, Danielle! Understanding where to put your extra money each month is incredibly important. In this post, I’ll explain what PMI is, the rules for eliminating it, and how to know when it should be your top financial priority.
What is Private Mortgage Insurance (PMI)?
If you take out a mortgage to buy a home or refinance an existing home loan, the last thing you want to hear is that you have to pay an additional charge, called private mortgage insurance or PMI. You might feel even worse when you find out that this insurance protects the lender, not you!
Borrowers have to shell out for PMI when they get a conventional mortgage but can’t put at least 20% down. The amount you borrow to buy a home is called the loan-to-value (LTV) ratio. For example, if you borrow $180,000 to buy a home valued at $200,000, you have a 90% LTV ($180,000 / $200,000 = 0.90)
Borrowers have to shell out for PMI when they get a conventional mortgage but can’t put at least 20% down.
When your LTV on a home mortgage is higher than 80%, lenders consider you to be a bigger risk than if you borrowed less. The lender mitigates that risk by requiring you to purchase PMI. The policy would cover a portion of their loss if you didn’t pay your mortgage and foreclosure proceeds don’t cover your outstanding loan balance.
However, there's a bright side to paying PMI. It makes it possible for many borrowers who can’t afford to put 20% down to buy a home. And it can be eliminated at certain LTV thresholds, which we’ll cover.
What’s the cost of PMI?
The cost of PMI varies depending on many factors. These include the type of mortgage you get, how much you put down, where the property is located, your credit, your loan term, and how lenders structure your PMI fee. In general, there are three ways lenders charge PMI:
- Monthly payments – which get added to your monthly mortgage payments. The premium could range from 0.2% to 1.5% of the balance on your loan each year. The annual cost is typically divided into 12 premiums and added to your monthly payments.
- Lump-sum payment – is a one-time premium that you pay upfront at closing. You may also pay both upfront and monthly premiums.
- Higher interest rate – a lender may charge a higher interest rate instead of itemizing separate PMI charges.
Monthly payments are the most common way that borrowers pay for PMI. Let’s say you get a 30-year, fixed-rate mortgage for $180,000 to buy a home valued at $200,000. With a 90% LTV and good credit, your PMI could cost about $100 per month.
Paying monthly PMI gives you the most transparency about the charge. It gets itemized on your mortgage statement, so you know exactly how much you're paying. And more importantly, you can see when it finally gets eliminated, which we'll cover next.
If your lender offers more than one way to pay PMI, ask for a detailed pricing comparison so you can weigh the pros and cons.
If you make a lump-sum PMI payment, it could turn out to cost more or less than the other options, depending on whether you choose to pay off your mortgage ahead of schedule. If you sell your home after just a few years or pay off your mortgage early, you don't get a return of any PMI premium.
Since mortgage interest is tax-deductible, the option to pay a higher interest rate instead of separate PMI payments could cost less on an after-tax basis. Also, PMI is currently a tax-deductible expense, although there have been periods when it wasn’t. At the end of the year, lenders send out Form 1098, which lists how much PMI and mortgage interest you paid during the year so that you can claim it on your tax return.
However, you can only claim these deductions if you itemize them using Schedule A. When your total itemized deductions are less than the standard deduction for your tax filing status, you'll save money claiming the standard deduction instead.
As you can see, knowing which option is best for paying PMI can be a bit complicated. If your lender offers more than one way to pay it, ask for a detailed pricing comparison so you can weigh the pros and cons and consider which option may cost less.
Rules for eliminating Private Mortgage Insurance
Now that you understand why and how lenders charge PMI, let’s review the rules for getting rid of it. That will help you know how high a priority it should be.
You should receive an annual notice from your mortgage lender that reminds you about your options to have PMI eliminated under certain conditions. Here are the ways you can get rid of monthly PMI payments.
When your mortgage balance reaches 78% of the original value of the property, PMI must automatically be canceled.
Request cancelation. After you pay down your mortgage balance to 80% of the original value of your home, you can ask for PMI to be canceled. Your original value can be either the price you paid for your home or its appraised value when you bought it (or refinanced it), whichever is less.
Your lender will require you to pay for a property appraisal to verify that your home’s value is the same or higher than when you purchased it. The appraisal fee could range from $300 to $1,000, depending on the size and location of your home.
Automatic termination. When your mortgage balance reaches 78% of the original value of the property, PMI must automatically be canceled. In this case, you don’t have to request it or pay for an appraisal.
Midpoint termination. When your mortgage balance reaches its midpoint, PMI must be automatically canceled. For example, if you have a 30-year mortgage, your lender must cancel your PMI after 15 years.
But keep an eye out for situations that might allow you to cancel PMI early, like when your home value appreciates due to market conditions. When your home value goes up, it lowers your LTV. Likewise, if you make additional mortgage payments that reduce your principal loan balance, it lowers your LTV. The faster you get to the 78% threshold, the sooner you can request a PMI cancellation.
Keep an eye out for situations that might allow you to cancel PMI early, like when your home value appreciates due to market conditions.
However, be aware that your lender can deny your request for PMI cancelation in certain situations, such as if you’ve made late payments. You must get current on any outstanding payments to have PMI canceled either as a request or automatically. Also, don’t forget that taking out a home equity loan or line of credit increases your LTV.
When should eliminating PMI be a financial priority?
Now that you understand when you must pay PMI and when you can eliminate it, let’s turn to Danielle’s question. She's considering whether to send extra money to her mortgage and get closer to canceling PMI or if it's better to pay off her student loan or car loan faster.
First, I’d recommend that Danielle zoom out and look at any other top financial priorities. She didn’t mention if she’s regularly contributing to a retirement account or has emergency savings. If she doesn’t have a healthy emergency fund, or she isn’t investing a minimum of 10% to 15% of her gross income for retirement, that’s where her extra money should go first.
We know that Danielle doesn’t have any dangerous debts, such as accounts in collections, credit cards with sky-high interest rates, or expensive payday loans. If she did, those would need attention before addressing any other type of debt. As she mentioned in her question, it’s generally best to pay off debt in order of highest to lowest interest rate.
So, assuming that Danielle’s finances are in good shape, how does paying PMI compare with a student loan and a small auto loan balance? While ongoing PMI payments aren’t an interest expense, you can pretend that they are as a technique for understanding their place in your financial life.
Let’s say you borrowed $180,000 for a $200,000 home, giving you a 90% LTV. As I previously mentioned, you need a 78% LTV to request PMI cancellation. So, you’d have to pay down your mortgage to $156,000 to get there. If you’re at the beginning of a loan term, you’d need to shell out $24,000 ($180,000 – $156,000 = $24,000).
If you were paying $100 a month or $1,200 a year for PMI, you could calculate it as a proxy for annual interest on a $24,000 loan. That comes out to an effective interest rate of 5% ($1,200 / $24,000 = 0.05). That’s an amount you’re paying on top of your mortgage interest rate. So, if your mortgage costs 4% in this example, you’d really be paying more like 9% during the years that you pay PMI.
The benefits of accelerating mortgage payments to get rid of PMI decrease if you’re able to deduct mortgage interest and PMI on your taxes.
However, this is an imperfect calculation because it’s doesn’t account for many factors. These include how much extra you pay toward your principal mortgage balance, how quickly equity builds as you prepay it, and any home appreciation.
Also, the benefits of accelerating mortgage payments to get rid of PMI decrease if you’re able to deduct mortgage interest and PMI on your taxes. A fixed-rate mortgage that costs 4% may only cost you 3% on an after-tax basis, depending on your effective income tax rate.
In general, prepaying a mortgage to eliminate PMI ahead of schedule may not help you as much as paying down other types of debt. Depending on where you live, factors such as real estate appreciation and general inflation are likely to work in your favor, making you eligible for PMI cancellation sooner than you may think.
A super simple way to evaluate the interest rate you’re paying for a mortgage with PMI is to tack on a percentage point or two. For instance, if your pre-tax mortgage rate is 4%, consider it actually costing you 5% to 6% tops. Or if you deduct interest and PMI, don’t factor in the tax implications and just consider the mortgage costing you the same as its stated interest rate, or 4% in my example.
If your other debts cost more than these very rough mortgage interest calculations, I’d be aggressive about getting rid of them first. Again, go in order of highest interest rate to lowest.
However, if you have a small outstanding balance that you just want to wipe out, there’s nothing wrong with that. Even if it costs you slightly less in interest, sometimes it just feels good to get rid of a small debt that’s been weighing you down.
What’s most important is that you understand how much you owe, the interest rates you’re paying, and that you have a plan for eliminating debt. Even if you don’t have extra money to pay off debt ahead of schedule, tacking them in the right order helps you save the most interest so you can eliminate debt as quickly as possible.
IRS Home Office Tax Deduction – Rules & Calculator
If youâre a small-business owner, freelancer, independent contractor, or self-employed person who maintains an office at home, you may qualify for a tax break by using the home office deduction. Done properly, this deduction can reduce your taxable income substantially, generating a tax savings.
IRS Home Office Tax Deduction – Rules & Calculator is a post from Money Crashers.
What Happens if I File My Taxes Wrong?
NOTE: Due to the COVID-19 coronavirus pandemic, the IRS has extended the federal tax filing and payment deadline to July 15, 2020. The recent relief package passed by Congress may have additional tax implications. Please contact a tax adviser for information you may need to complete your taxes this year. Learn More. When tax season hits, many… Read More
The post What Happens if I File My Taxes Wrong? appeared first on Credit.com.
How To Start A Business With No Money
It is possible to start a business with no money and avoid taking on debt. Here’s how to get started, even if you don’t have much cash.
The post How To Start A Business With No Money appeared first on Bible Money Matters and was written by Marc. Copyright © Bible Money Matters – please visit biblemoneymatters.com for more great content.
What Is A Consumer Loan?
A consumer loan is a loan or line of credit that you receive from a lender. Consumer loans can be auto loans, home mortgages, student loans, credit cards, equity loans, refinance loans, and personal loans. This article will address each type of consumer loans. Get Approved for personal loan today. Types of consumer loans: Consumer …
Continue reading “What Is A Consumer Loan?”
The post What Is A Consumer Loan? appeared first on GrowthRapidly.
Which Debts Should You Prepay First? A 6-Step Plan
Maya asks:
“Is it better to pay off student loans or a mortgage first? I’m asking for my brother, who took out $80,000 in student loans about 20 years ago and has only paid off about $10,000. He recently bought a home in Southern California and took out a 30-year mortgage that might be as much as $400,000. I don’t know the interest rates he’s paying on these debts. I think he should pay off his student loans first because the total debt is smaller, older, and can’t be discharged in a bankruptcy. What do you think?”
Thanks for your question, Maya! This dilemma is common, especially now that most federal student loans are in automatic forbearance from March 13 to September 30, 2020, due to coronavirus-related economic relief. That means millions of student loan borrowers suddenly have the option to stop making payments without adverse financial consequences, such as hurting their credit or getting charged additional interest or fees.
If you have qualifying student loans and you're dealing with financial hardship due to the pandemic or another challenge, you may be grateful to have your payments suspended. But if your finances are in good shape and you don’t have any dangerous debts, such as high-rate credit cards or loans, you may be wondering what to do with the extra money. Should you send it to your student loans despite the forbearance, to your mortgage, or to some other account?
RELATED: 10 Things Student Loan Borrowers Should Know About Coronavirus Relief
6 Steps to Decide Whether to Pay Off Student Loans or a Mortgage First
Let's take a look at how to prioritize your finances and use your resources wisely during the pandemic. This six-step plan will help you make smart decisions and reach your financial goals as quickly as possible.
1. Check your emergency savings
While many people begin by asking which debt to pay off first, that’s not necessarily the right question. Instead, zoom out and consider your financial life's big picture. An excellent place to start is to review your emergency savings.
If you’ve suffered the loss of a job or business income during the pandemic, you’re probably very familiar with how much or how little savings you have. But if you haven’t thought about your cash reserve lately, it’s time to reevaluate it.
Having emergency money is so important because it keeps you from going into debt in the first place. It keeps you safe during a rough financial patch or if you have a significant unexpected expense, such as a car repair or a medical bill.
How much emergency savings you need is different for everyone. If you’re the sole breadwinner for a large family, you may need a bigger financial cushion than a single person with no dependents and plenty of job opportunities.
If you’re the sole breadwinner for a large family, you may need a bigger financial cushion than a single person with no dependents and plenty of job opportunities.
A good rule of thumb is to accumulate at least 10% of your annual gross income as a cash reserve. For instance, if you earn $50,000, make a goal to maintain at least $5,000 in your emergency fund.
You might use another standard formula based on average monthly living expenses: Add up your essential costs, such as food, housing, insurance, and transportation, and multiply the total by a reasonable period, such as three to six months. For example, if your living expenses are $3,000 a month and you want a three-month reserve, you need a cash cushion of $9,000.
If you have zero savings, start with a small goal, such as saving 1 to 2% of your income each year. Or you could start with a tiny target like $500 or $1,000 and increase it each year until you have a healthy amount of emergency money. In other words, it might take years to build up enough savings, and that’s okay—just get started!
Your financial well-being depends on having cash to meet your living expenses comfortably, not on paying a lender ahead of schedule.
Unless Maya’s brother has enough cash in the bank to sustain him and any dependent family members through a financial crisis that lasts for several months, I wouldn’t recommend paying off student loans or a mortgage early. Your financial well-being depends on having cash to meet your living expenses comfortably, not on paying a lender ahead of schedule.
If you have enough emergency savings to feel secure for your situation, keep reading. Working through the next four steps will help you decide whether to pay down your student loans or mortgage first.
2. Reach your retirement goals
In addition to saving for potential emergencies, it’s critical to save regularly for your retirement before paying down a student loan or mortgage early. So, if Maya’s brother isn’t contributing regularly to meet a retirement goal, that’s the next priority I’d recommend for him.
Consider this: If you invest $500 a month for 35 years and have an average 8% return, you’ll end up with an impressive retirement nest egg of more than $1.2 million! But if you wait until 10 years before retirement to start saving, you’d have to invest over $5,000 a month to have $1 million in the bank. When it comes to your retirement savings, procrastinating can make the difference between scraping by or have a comfortable lifestyle down the road.
When it comes to your retirement savings, procrastinating can make the difference between scraping by or have a comfortable lifestyle down the road.
A good rule of thumb is to invest at least 10% to 15% of your gross income for retirement. For instance, if you earn $50,000, make a goal to contribute at least $5,000 per year to a tax-advantaged retirement account, such as an IRA or a retirement plan at work, such as a 401(k) or 403(b).
For 2020, you can contribute up to $19,500, or $26,000 if you’re over age 50, to a workplace retirement account. Anyone with earned income (even the self-employed) can contribute up to $6,000 (or $7,000 if you’re over 50) to an IRA.
The earlier you make retirement savings a habit, the better. Not only does starting sooner give you more time to contribute money, but it leverages the power of compounding, which allows the growth in your account to earn additional interest. That’s when you’ll see your retirement account value mushroom!
3. Have the right insurance
In addition to building an emergency fund and saving for retirement, an essential part of taking control of your finances is having adequate insurance. Many people get into debt in the first place because they don’t have enough of the right kinds of coverage—or they don’t have any insurance at all.
Without enough insurance, a catastrophic event could wipe out everything you’ve worked so hard to earn.
As your career progresses and your net worth increases, you’ll have more income and assets to protect from unexpected events. Without enough insurance, a catastrophic event could wipe out everything you’ve worked so hard to earn.
Make sure you have enough health insurance to protect yourself and those you love from an illness or accident jeopardizing your financial security. Also, review your auto and home or renters insurance coverage. And by the way, if you rent and don’t have renters insurance, you need it. It’s a bargain for the protection you get; it only costs $185 per year on average.
And if you have family who would be hurt financially if you died, you need life insurance to protect them. If you’re in relatively good health, a term life insurance policy for $500,000 might only cost a couple of hundred dollars per year. You can get free quotes for many different types of insurance using sites like Bankrate.com or Policygenius.com.
If Maya’s brother is missing critical types of insurance for his lifestyle and family situation, getting it should come before paying off a student loan or mortgage early. It’s always a good idea to review your insurance needs with a reputable agent or a financial advisor who can make sure you aren’t exposed to too much financial risk.
4. Set other financial goals
But what about other goals you might have, such as saving for a child’s education, starting a business, or buying a home? These are wonderful if you can afford them once you’ve accounted for your emergency savings, retirement, and insurance needs.
Make a list of your financial dreams, what they cost, and how much you can afford to spend on them each month. If they’re more important to you than paying off student loans or a mortgage early, then you should fund them. But if you’re more determined to become completely debt-free, go for it!
5. Consider your opportunity costs
Once you’ve hit the financial targets we’ve covered so far, and you have money left over, it’s time to consider the opportunity costs of using it to pay off your student loans or mortgage. Your opportunity cost is the potential gain you’d miss if you used your money for another purpose, such as investing it.
A couple of benefits of both student loans and mortgages is that they come with low interest rates and tax deductions, making them relatively inexpensive. That’s why other high-interest debts, such as credit cards, personal loans, and auto loans, should always be paid off first. Those debts cost more in interest and don’t come with any money-saving tax deductions.
Especially in today’s low interest rate environment, it’s possible to get a significantly higher return even with a reasonably conservative investment portfolio.
But many people overlook the ability to invest extra money and get a higher return. For instance, if you pay off the mortgage, you’d receive a 4% guaranteed return. But if you can get 6% on an investment portfolio, you may come out ahead.
Especially in today’s low-interest-rate environment, it’s possible to get a significantly higher return even with a reasonably conservative investment portfolio. The downside of investing extra money, instead of using it to pay down a student loan or mortgage, is that investment returns are not guaranteed.
If you decide an early payoff is right for you, keep reading. We’ll review several factors to help you know which type of loan to focus on first.
6. Compare your student loans and mortgage
Once you have only student loans and a mortgage and you’ve decided to prepay one of them, consider these factors.
The interest rates of your loans. As I mentioned, you may be eligible to claim a mortgage interest tax deduction and a student loan interest deduction. How much savings these deductions give you depends on your income and whether you use Schedule A to itemize deductions on your tax return. If you claim either type of deduction, it could reduce your after-tax interest rate by about 1%. The debt with the highest after-tax interest rate is typically the best one to pay off first.
The amounts you owe. If you owe significantly less on your student loans than your mortgage, eliminating the smaller debt first might feel great. Then you’d only have one debt left to pay off instead of two.
You have an interest-only adjustable-rate mortgage (ARM). With this type of mortgage, you’re only required to pay interest for a period (such as several months or up to several years). Then your monthly payments increase significantly based on market conditions. Even if your ARM interest rate is lower than your student loans, it could go up in the future. You may want to pay it down enough to refinance to a fixed-rate mortgage.
You have a loan cosigner. If you have a family member who cosigned your student loans or a spouse who cosigned your mortgage, they may influence which loan you tackle first. For instance, if eliminating a student loan cosigned by your parents would help improve their credit or overall financial situation, you might prioritize that debt.
You qualify for student loan forgiveness. If you have a federal loan that can be forgiven after a certain period (such as 10 or 20 years), prepaying it means you’ll have less forgiven. Paying more toward your mortgage would save you more.
Being completely debt-free is a terrific goal, but keeping inexpensive debt and investing your excess cash for higher returns can make you wealthier in the end.
As you can see, the decision to eliminate debt and in what order, isn’t clear-cut. Mortgages and student loans are some of the best types of debt to have—they allow you to build wealth by accumulating equity in a home, getting higher-paying jobs, and freeing up income you can save and invest.
In other words, if Maya’s brother uses his excess cash to prepay a low-rate mortgage or a student loan, it may do more harm than good. So, before you rush to prepay these types of debts, make sure there isn’t a better use for your money.
Being completely debt-free is a terrific goal, but keeping inexpensive debt and investing your excess cash for higher returns can make you wealthier in the end. Only you can decide whether paying off a mortgage or student loan is the right financial move for you.
What is Accidental Death Insurance, and do you Need it?
Accidental death insurance, also known as accidental death and dismemberment insurance, is a type of limited life insurance often acquired for a nominal fee or added to an existing policy. As the name suggests, it releases a benefit if the policyholder dies from an accident or suffers a dismemberment. Accidents kill an estimated 160,000 Americans […]
What is Accidental Death Insurance, and do you Need it? is a post from Pocket Your Dollars.
7 Money Steps to Take Before 2021
With the end of the year rapidly approaching, itâs a good time to take stock of your financial situation as you head into 2021. 2020 has been a strange year, and a difficult year for many people. With many peopleâs…
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The post 7 Money Steps to Take Before 2021 appeared first on MintLife Blog.