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I'm a brand new home seeker - about to close deal on a brand new house.

From what I can gather by reading posts here, it seems to me that it's typical in amortization schedules to pay off interest first, principal last (ie: 95% interest, 5% principal) at first and at the end of 30-year schedule, it would look more like this - 95% principal, 5% interest.

I haven't made calculations, but my (somewhat limited) thinking seem to tell me I'll be much better off if I pay off 100% principal first before paying ANY interest - that way I have much lesser interest to deal with.

What am I missing?

Craig
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<<From what I can gather by reading posts here, it seems to me that it's typical in amortization schedules to pay off interest first, principal last (ie: 95% interest, 5% principal) at first and at the end of 30-year schedule, it would look more like this - 95% principal, 5% interest.

I haven't made calculations, but my (somewhat limited) thinking seem to tell me I'll be much better off if I pay off 100% principal first before paying ANY interest - that way I have much lesser interest to deal with.

What am I missing? >>

I think what you might be missing is that you don't get to chose what you pay first - it's in the motgage note. But maybe you can find a mortgage company with a different amortization schedule ?

Jacki

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I think what you might be missing is that you don't get to chose what you pay first - it's in the motgage note. But maybe you can find a mortgage company with a different amortization schedule ?

Jacki

I think you're missing my real question here. The percentages I used are just an example, not actual. My question is, it seems logical to me that home-owners should pay off principal first, that way they have lesser interest to deal with, which would mean huge savings over the life of 30-year loans.

But it seems to me that's not the case.. everywhere I've looked, you pay off interest first, then principal last (actually you pay both at same time, but more interest at first, less later)

Craig
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I think you're missing my real question here. The percentages I used are just an example, not actual. My question is, it seems logical to me that home-owners should pay off principal first, that way they have lesser interest to deal with, which would mean huge savings over the life of 30-year loans.

But it seems to me that's not the case.. everywhere I've looked, you pay off interest first, then principal last (actually you pay both at same time, but more interest at first, less later)

Craig

No mortgage lender will give you an amortization schedule that pays off principal first. It puts all the risk on the lender instead of on the lendee.

You can get some of the advantages of paying off principle first by adding extra principal to your regular mortgage payment. [Read the fine print.] Most mortgage lenders let you do that without penalty and this can indeed save you gobs and gobs [a highly technical unit of measurement] of money.

Here's a calculater that given a time period will tell you how much you will have to add to your mortgage payment and how much you will save in interest.

http://www.interest.com/hugh/calc/duration.cgi

For example, \$100,000 loan @ 7.25% and you want to pay it off in 15 years (instead of 30). Add \$233.51 extra to your \$682.18 payment and save \$80,759.95 in interest over the life of the loan.

P.S. Check out this site, links to calculators of all sorts.

http://www-sci.lib.uci.edu/HSG/RefCalculators.html
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Hi Craig,

I may be missing your question, too, but the reason more interest is paid up front is that more loan money is outstanding up front. As the size of the loan decreases, the amount of interest decreases as well. Now, you are correct that it makes more sense to pay more principal up front because you save a lot of interest over the life of the loan and you can almost always do this (unless you have a "no pre-payment" clause in your loan). On my mortage slip there is a line for extra amounts included and two check boxes to choose from: (1) reduce principal (2) reduce future payments. Choosing 1 will go directly towards reducing your principal. I hope that helps and

Fool on,

TMF Deal
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Craig: TMF Deal gave the best explanation. Interest is due each month as it accrues; thus, it will be the largest the first full moth after closing (or refinancing). The amount you pay in excess of the required interst reduces the principal. The next month a slighly smaller interest payment is due (becasue of the smaller outstanding principal balance) and this results in a slightly bigger principal reduction.

I have tried to attached a portion of a simple spreadsheet amortization schedule tht I use, but I could not make all the columns line-up correctly; instead it took to rows to show all the columns instead of one.

Calculations are for 100k loan @ 7.5% (it show .08 becasue of rounding) for 30-year amortization. Column headings are Principal amount (at beginning of month); interest rate; interest (per month); payment; Principal reduction (payment - intrest); and new principal balance. I hope this helps . . .

Prin. Bal. i rate int. payment P. reduce. new bal.
\$100,000.00 0.08 \$625.00 \$699.21 \$74.21 \$99,925.79
\$99,925.79 0.08 \$624.54 \$699.21 \$74.67 \$99,851.12
\$99,851.12 0.08 \$624.07 \$699.21 \$75.14 \$99,775.98
\$99,775.98 0.08 \$623.60 \$699.21 \$75.61 \$99,700.37
\$99,700.37 0.08 \$623.13 \$699.21 \$76.08 \$99,624.28
\$99,624.28 0.08 \$622.65 \$699.21 \$76.56 \$99,547.72
\$99,547.72 0.08 \$622.17 \$699.21 \$77.04 \$99,470.69
\$99,470.69 0.08 \$621.69 \$699.21 \$77.52 \$99,393.17
\$99,393.17 0.08 \$621.21 \$699.21 \$78.00 \$99,315.17
\$99,315.17 0.08 \$620.72 \$699.21 \$78.49 \$99,236.68
\$99,236.68 0.08 \$620.23 \$699.21 \$78.98 \$99,157.70
\$99,157.70 0.08 \$619.74 \$699.21 \$79.47 \$99,078.22

To pay more principal at the beginning, you can add additional amounts to the required payments and pray principal (assuming that partial prepayments are permitted under your loan documents).

Regards, JAFO
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Hi Craig. The following is not meant to be either disparaging or demeaning. I think what you are missing is a fundamental understanding of what amortisation is. Amortisation is nothing more than a mathematical calculation that provides for the repayment of a loan in even payments made over the entire term of the loan. That's it.

Let's look at an example that may help you to understand that interest/principal allocation thing that is so bothersome. I mean it; it bothers me too, but it's the way it is. Let's suppose you borrow \$100,000 at 7.25% on a 30 year loan. Your required payment in order to amortize the loan (pay it off at the exact projected future time) is \$682.18. We find this figure out via a calculator these days. 45years ago someone had to figure the payment out through laborious trial and error calculations until the correct number was found. That number was recorded in thick volumes which became known as the Ellwood Tables. Anybody out there remember the Ellwood Tables?

Anyway, as I was saying before I was overcome with nostalgia, here's how thnigs work. In any monthly mortgage payment you are paying first the interest for having used someone else's money for the previous month. In our case you used someone else's \$100,000 for a month. At 7.25% simple interest that comes to \$7,250 per annum, or \$604.17 for the month. So first you pay the rent on the money out of your \$682.18 payment because someone wants to get 7.25% return on their money (\$100,000)that you have the use of. That leaves %78.01 to reduce the principal. Your principal balance is now \$99,921.99. For the next month your interest expense is a little less--\$603.70. This represents 1/12 of 7.25% of \$99,921.99. So the second month your principal payment increases to \$78.48. This goes on month after month until the loan is paid off. Your monthly P & I payment is nothing more than the mathematically proven figure required to achieve the payoff via equal monthly payments.

There is no reason you couldn't pay off the principal first. It's called a cash purchase. (I have argued against such an approach in other posts, and will not repeat myself here.) In any other scenario you are simply paying someone for the use of their money. They want a return on their investment just as you would if you purchased a bond. The only difference, essentially, between a holding a mortgage and a owning a bond is that with a bond you get all interest payments until the end, when you get your investment back, and with a mortgage you get some of both each month. The calculation of how much of each you get is called an amortisation schedule.

Hope this helps. If not, restate your question.

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Anyway, as I was saying before I was overcome with nostalgia, here's how thnigs work. In any monthly mortgage payment you are paying first the interest for having used someone else's money for the previous month. In our case you used someone else's \$100,000 for a month. At 7.25% simple interest that comes to \$7,250 per annum, or \$604.17 for the month. So first you pay the rent on the money out of your \$682.18 payment because someone wants to get 7.25% return on their money (\$100,000)that you have the use of. That leaves %78.01 to reduce the principal. Your principal balance is now \$99,921.99. For the next month your interest expense is a little less--\$603.70. This represents 1/12 of 7.25% of \$99,921.99. So the second month your principal paymentincreases to \$78.48. This goes on month after month until the loan is paid off. Your monthly P & I payment is nothing more than the mathematically proven figure required to achieve the payoff via equal monthly payments.

Everyone gave good answers, but dharamdolllars hit the nail right on the head with the answer I was looking for - what I didn't realize is in the first month and for awhile after that, the principal owed is so high that the interest actually adds up that MUCH in a month. Now all of it makes sense! Thanks everyone and dharmadollars!

I think it's Foolish (capital F) to invest the prepay money instead because my rate is relatively low: 6.167% (average over 30 years, it really is 4.5% for first 5 years, 6.5% for remaining 25 years). I'm confident that over the years, I can have a return of much more than 6.167%.

Craig
No. of Recommendations: 1
"I think it's Foolish (capital F) to invest the prepay money instead because my rate is relatively low:
6.167% (average over 30 years, it really is 4.5% for first 5 years, 6.5% for remaining 25 years).
I'm confident that over the years, I can have a return of much more than 6.167%."

Congratulations, Craig!! You're a Foolish salmon. Now, if you could just tell me how to copy quotes from a previous post into the current one, and get them to print in italics, I'd really be grateful!!

Haven't run into those Ellwood Tables, huh?

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Now, if you could just tell me how to copy quotes from a previous post into the current one, and get them to print in italics, I'd really be grateful!!

Hey Dharmadollars... I know you didn't ask ME but I figured that I would be able to help with your problem. I know you have helped numerous people around here, so its the least that I could do...

Anyway, any text that is typed between "< I >" and "< /I >" (no spaces between the quotes, if I would have left them out, they would not have been shown and the word and would have been italized.) Bold face works the same way, except with a B instead of an I.

So, to answer your question... if you want to include part of someone elses reply, simply point your cursor at the beginning of what you want to copy, click your left mouse button, and drag the mouse over what you want to copy, and let go of the button.

Now, hold down control, and press C. This will copy what's highlighted into a special place in memory on your computer. You won't see anything change. Now, click in the box where you would type your reply, and type the tag to begin italizing... ("< I >", with no spaces), now, hold down control and press V. This will paste in what you copied before. Now, type in the tag to end the italics (I'm sure you can figure out what that is!).

Now, hit return and type your reply... that's it... Sorry for the long-winded-assuming-your-computer-illiterate-description, but I'm sure you can figure it out from this post. Its normally better to assume that that someone knows very little, then to assume too much.

This is also assuming that you are using a PC, rather then a mac or some other operating system. In that case, your control keys may be different, and I would suggest using the menus (normally under edit) to find the command to copy and paste.

Oh! And one last tip... for your first couple posts, it may be useful to hit the preview button... just so that if you made a mistake, it doesn't get posted on the message boards for all of eternity... :)

Hope this helps!

Fool on!

Ryan
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Hey, Ryan. Thanks for the tutorial. Exactly the level of instruction I needed. Now, how do you import those neat URLs that show up in blue? Inquiring minds want to know!!

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Now, how do you import those neat URLs that show up in blue? Inquiring minds want to know!!

well, the fool boards make this one easy. Just type out the name of the website, with or without the leading http.

Example:

www.fool.com
http://www.fool.com

I didn't have to type anything funny to get those to be linked.

Glad to be of service... Hopefully, this thread isn't bothering anyone reading this board. If so, we can move this conversation elsewhere, or rename the thread.

Fool On!

Ryan
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Now that you understand how the stuff works, if you want to have a little fun, get the amortization table from your lender and also ask them for the formula they use to calculate the numbers. Then go home and see if they know what they're talking about.

We did this once on an interest-bearing checking account. Took 3 tries and 3 different people before the bank got it right. We switched banks.

Kathleen
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Each Month you are paying interest on what you owe. So if you have a \$100,000 loan outstanding at a 7% annual interest rate, the first month you'll pay 7%/12*100,000 in interest = \$583.33 in interest. Your payment is \$665.30. That leaves \$82 that goes towards principal. The next month you still have a loan of \$100,000 - \$82 = \$99,918 outstanding. You owe interest in the amount of 7%/12*99,918 = \$582.86. And so on

So where does the total payment amount come from? As I mentioned before, that amount is \$665.30. It's the number you get if you ask the question: What payment made every month for 360 months has a net present value of \$100,000 given an annual interest rate of 7%? Mortgage loans are loans made against your income. Lenders figure that if you have a steady income, you can make steady payments towards homeownership. So that's why mortgage loans are structured as fixed payment, fully amortizing loans.

Some lenders allow you to pay more towards principal each month by increasing your total monthly payment(that will reduce the amount of your loan outstanding, and as a result reduce the amount of interest you owe next month), but lenders always want you to pay the interest you owe on the principal outstanding. Hope this helps.
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a) try to get an 80% loan to value (ltv) along with a home equity loan of 15% ltv and a 5% down payment. This eliminates your PMI which serves you no benefit...it only serves the bank. The added interest on the second loan more than pays for itself as it is tax deductible.

b) Hugh's mortgage and financial calculators is a good web site to view amortization (sic) schedules.

c) paying off added principal with each monthly payment will save you years of payments and lots of interest

d) good luck
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a) try to get an 80% loan to value (ltv) along with a home equity loan of 15% ltv and a 5% down payment. This eliminates your PMI which serves you no benefit...it only serves the bank. The added interest on the second loan more than pays for itself as it is tax deductible.

What exactly triggers the elimination of PMI? 5% down payment? Or a combination of all those?

b) Hugh's mortgage and financial calculators is a good web site to view amortization (sic) schedules.

Supplying an URL address would be nice - I know how to do a keyword search nevertheless :)

c) paying off added principal with each monthly payment will save you years of payments and lots of interest

It's MUCH more effective, in my opinion, to invest the prepay money instead as long as I make sure my annual return is over the annual mortgage rate, after taxes, commissions, etc. My average mortgage rate is relatively low, 6.167% (4.5 for first 5 years, 6.5 for remaining 25 years), and I'm confident I can do at least 15%, so I'm going to invest my prepay money instead. I think some would agree that's the Foolish way to go.

d) good luck

Thanks!

Craig
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What exactly triggers the elimination of PMI? 5% down payment? Or a combination of all those?

Some would argue that nothing short of the earth spinning uncontrollably off of it's axis would eliminate PMI if you are already paying it.

The 80% ltv eliminates PMI at the start of a mortgage so you would combine the 5% down with the 15% home equity. Most lenders will combine these for you at closing so you don't pay any additional costs for the equity loan.

We just closed in January on our first house using this method with a 10% down payment. Our lender called it an 80/10/10. A little more cash outlay up front was well worth eliminating the \$93 firestarter (read PMI payment) that may as well go up in smoke.

If you do pay a PMI premium I think you have to do so at least for two years and then you can apply to have it eliminated assuming that after two years you have achieved the 80% ltv.

TyWebb33
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Graig
Are you suggesting that all applicable laws allow you to structure your loan whereby you leave off paying interest until all principal is paid? If there isn't a law, there should be. I'd be interested to know if you find one.
Ned
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IT ENDS UP THE SAME EITHER WAY. AFTER EACH MONTH, YOU OWE AN AMOUNT (UNPAID PRINCIPAL BALANCE + UNPAID INTEREST.) IT DOES NOT MATTER WHICH YOU APPLY YOU PAYMENT TO, YOU STILL OWE THE AMOUNT ABOVE LESS YOUR PAYMENT. THE NEW BALANCE IS WHAT IS OWED, THUS INTEREST IS ACCUMULATED OVER THE NEXT MONTH AT YOUR INTEREST RATE (REGUARDLESS IF IT IS UNPAID PRINCIPAL OR UNPAID INTEREST)

NICE TRY THOUGH
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FIRTHDOG wrote " IT ENDS UP THE SAME EITHER WAY. AFTER EACH MONTH, YOU OWE AN AMOUNT (UNPAID PRINCIPAL BALANCE + UNPAID INTEREST.) IT DOES NOT MATTER WHICH YOU APPLY YOU PAYMENT TO, YOU STILL OWE THE AMOUNT ABOVE LESS YOUR PAYMENT. THE NEW BALANCE IS WHAT IS OWED, THUS INTEREST IS ACCUMULATED OVER THE NEXT MONTH AT YOUR INTEREST RATE (REGARDLESS IF IT IS UNPAID PRINCIPAL OR UNPAID INTEREST)."

I disagree. Interest does not necessarily "accumulate over the next month at your interst rate (regardless if it is unpaid principal or unpaid interest)."
Not paying interest that is due is a default, and subject to whatever grace period or notice and opportunity to cure provisions exist in the note and other loan documents, lenders (among other possible choices) are typically allowed to increase the interest on past due interest - - - meaning that it would be accruing at a rate greater than the interest rate on the principal amount.

Just my \$0.02. Regards, JAFO
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FIRTHDOG - just in case you do not know, posting in ALL CAPS is considered the equivalent of shouting and generally is to be avoided as being rude.

JAFO
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Re: aoneaone's post:

... along with a home equity loan of 15% ltv...

The approach is a good one; the specifics are a little off. You can't get a home equity loan against a property you don't own. What you need is a purchase money second mortgage.

Re: c) I continue to disagree with this strategy for my oft-stated reasons.

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I'm not an accountant, but here's how my loan works: Just take your annual interest rate, divide it by 12, then multiply that figure by your unpaid balance. That is what your next month's interest charge will be. On a conventional simple-interest loan you are charged interest on what you owe, no more, no less. The interest is not loaded up front. Its just more at first because you owe more at first....
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There is a way to pay more principal first, if you wish. Take out a one year ARM and make voluntary prepayments of principal, whenever you wish.
Each year the remaining principal will be reset, which means that your monthly payment of both interest and principal will be reduced if you have made prepayments.(assuming interest rates remain steady--which is not likely). This is a great deal for people who want to pay off their mortgage quickly and reduce the amount of interest they pay. But remember! Interest is tax deductible, so it really doesn't cost you as much as you think it does--provided you are in a high tax bracket
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I am not a finacial anything but remember that a mortgage is a fancy loan. The bank makes money by interest. If you paid 100% principal the transaction would just be a cash deal replacing only what you barrowed. The bank would get nothing from letting you use thier money. Ask the bank if you can do the 100% principal but I bet they say no.

Also remember that the interest on a first home is tax deductible. It doesn't give 100% of th interest back but your tax refund does become larger. Hope you get lots of answers and one of them tells you how to make the 100 principal work. them you cna post it in the fool.
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<< and I'm confident I can do at least 15%, >>

IMHO, you are overconfident. It would be foolish not Foolish
to base your expectations on the returns from the last 5 years.

Many older people base their attitudes to investing on 1929 - 1935, which is also not Foolish.
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<< and I'm confident I can do at least 15%, >>

IMHO, you are overconfident. It would be foolish not Foolish to base your expectations on the returns from the last 5 years

Many older people base their attitudes to investing on 1929 - 1935, which is also not Foolish.

And what makes YOU say that? What gives you the right to make assumptions? :) You look kinda silly not even knowing my other aspects.

Maybe your investing skills/portfolio isn't as Foolish as you think it is? If you can't make a return that beats the market, you aren't that good.

Granted, there will be some bad years, but remember, the term of my loan is 30 years long. Of course there will be some bad years, but I'll be grinning at the end of the life of loan when I'm making huge payoffs that I have invested instead of prepaying.

I got a recommendation for you: read #183. If you still disagree with investing, then so be it. I wish you lots of luck in the future. ;)

Craig

No. of Recommendations: 0
<<
Granted, there will be some bad years, but remember, the term of my loan is 30 years long. Of course there will be some bad years, but I'll be grinning at the end of the life of loan when I'm making huge payoffs that I have invested instead of prepaying.

I got a recommendation for you: read #183. If you still disagree with investing, then so be it. I wish you lots of luck in the future. ;)
>>

I am sorry I offended you. I read post #183. I am fully
invested in the market, I am reading this board to learn
a little about buying a home. Someday I hope to have a mortgage.:-)

You are correct I do not know why you would be able to
obtain 15% return on you investment.

Historically the stock market return in around 10%, after 15%
capital gains tax the return would be 8.5%. Most actively
managed mutual funds have not beaten the S&P over the
last few years. If the professionals do not beat the
market consistently then I may not be able to either.

I am happy to report that so far this year I am beating
the S&P 500,:-)

Good luck with your investing,I hope it works out even better than you imagine.
No. of Recommendations: 0
Historically the stock market return in around 10%, after 15% capital gains tax the return would be 8.5%. Most actively managed mutual funds have not beaten the S&P over the last few years. If the professionals do not beat the market consistently then I may not be able to either.

Hmm.. If you've been reading around a bit at The Motley Fool, you might get the idea that generally mutual funds isn't the way to go, unless it's an index fund. 98% (if I'm not mistaken) of the funds do not beat the market regularly.

You might want to go to The School section of the Motley Fool website and read up on the 13 steps.

If you've done all that already, then disregard what I said.

You might want to check out Fool Four portfolio, and the Rulebreaker concept (ie: you cannot follow Rulebreaker portfolio the Fool website has now, but understand why those stocks are picked and pick the ones that will fit those criteria today)

Craig

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Craig,
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The part that you are missing is that the banks needs and wants to make money off your loan for lending you all those big bucks. It's like going to Vegas, the odds are always in favor of the house (bank). It IS better to pay down the principal....but they want the interest.
No. of Recommendations: 1
Of course they want the interest. So do you if you buy a bond or invest in a bond fund. You want a return on your investment if you buy stocks? So why is it good when you do it and bad when the bank does it?

And why IS it better to pay down the principal? Why isn't it better to take the excess cash and invest it at a return higher than the cost of borrowing?

No. of Recommendations: 0

And why IS it better to pay down the principal? Why isn't it better to take the excess cash and invest it at a return higher than the cost of borrowing?

I believe that this is a personal decision. Myself, I am agressivly paying down the principal of my mortgage. It is the single biggest expense I have. In 10 years (or less) when it is payed off, I plan on working part time instead of full time. Then 20 years later when I finally get to 65 I will retire and live off of my investments. Yes I have also started investing, and am learning more about Foolish investments.

I also noticed in previous post about buying a house with 20% down to avoid PMI. Well I have purchased 2 houses with NOTHING DOWN and never paid PMI. The short version of this story is in both cases I went to the seller and made an agreement (Contract For Deed) to cover a short period of time while I was aranging financing of a conventional mortgage. Becasue I was already the owner (by the CFD) I was able to get the mortgage as a REFINANCE, and both properties were then appraised at a level where the borrowed (purchased) amount was 80% of their value.

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I am buying a townhouse for \$158,500 putting 20% down to avoid PMI.. I was told that i can get SonyMa mortgage which is at 5 1/2% because i only make 35k a year. Although I will have to wait till July to lock in because seller wont move till September 30. But i can lock in for 90 days. What you think? how did you get a house with no PMI with nothing down? maybe i can do this to??
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jimellis wrote, in part, "I also noticed in previous post about buying a house with 20% down to avoid PMI. Well I have purchased 2 houses with NOTHING DOWN and never paid PMI. The short version of this story is in both cases I went to the seller and made an agreement (Contract For Deed) to cover a short period of time while I was aranging financing of a conventional mortgage. Becasue I was already the owner (by the CFD) I was able to get the mortgage as a REFINANCE, and both properties were then appraised at a level where the borrowed (purchased) amount was 80% of their value."

You do not say what state you are in but I do not beleive that this strategy would work in Texas. As I understand contracts for deed the deed is not delivered (and possibly not even executed) until final payment is made. Thus, the contract for deed purchaser would not be the "owner" for prposes of refinancing.

Just my \$0.02. Regards, JAFO

P.S. Sorry if this is a little late, but I have been out of town for a week.