What's New in Financial Strategies – May 2011

It's not too late to convert to a Roth IRA

If you procrastinated on converting your regular IRA to a Roth last year, you can still do so in 2011. Although converting your IRA generates taxable income in the year of the transfer, later withdrawals of contributions and income from the Roth are tax-free. Making this transfer while income tax rates remain low could pay off big time. And your conversion opportunities are not limited to just traditional IRAs. You can also convert your 401(k), 403(b), or 457 plan to a Roth.

What you need to know about private mortgage insurance

If you're in the market for a home, you've probably heard of private mortgage insurance or PMI. It's insurance that protects lenders - not borrowers - if the mortgage goes into default. Lenders generally require PMI if you're unwilling or unable to make a down payment of at least 20% of the home's purchase price. Depending on your credit history, your income, the size of your mortgage and other factors, PMI can run from $50 to several hundred dollars a month. After building up equity in your home (in technical terms, when your loan-to-value ratio drops below 80% of the original loan balance), your PMI policy can be cancelled. But building up that much equity, especially with a conventional long-term mortgage, can take a decade or longer.

Is everyone who can't afford a 20% down payment required to take out a PMI policy? If you're financing a home with a conventional mortgage, the short answer is: probably. Homes financed with a Veteran's Administration (VA) or Federal Housing Administration (FHA) mortgage don't require PMI. That's because the federal government protects these lenders by paying off the outstanding mortgage balance if the borrower defaults. Lenders who finance conventional mortgages don't have that protection. From the lender's perspective, if you borrow more than 80% of the home's market value, you're more likely to default on the loan. To compensate for this greater perceived risk, conventional mortgage lenders generally require you to purchase PMI. Those lenders who don't require PMI will compensate for their risk in other ways, such as jacking up your mortgage's interest rate.

On the plus side, a conventional mortgage with PMI may enable you to acquire a home that's otherwise outside your budget. On the other hand, the availability of PMI may entice you to purchase a home that's more expensive than you can realistically afford. Consider also that PMI premiums add an extra cost to your monthly house payment.

So if you're looking to finance that dream home, be sure to consider all the factors - including PMI. If you need assistance, give us a call.