In this edition of Getting Personal, Chris and Tess talk about private mortgage insurance, 457s vs. 403(b)s, removing a co-signer and borrowing from a 401(k).
TESS VIGELAND: It's time for Getting Personal and that's when we answer your money questions. With me once again is our Economics Editor, Chris Farrell. Hello again, Chris.
CHRIS FARRELL: It's good to be back with you.
TESS: All right, our first caller is Angela and she is Washington, D.C. Hi, Angela?
ANGELA FROM WASHINGTON, DC: Hi, Tess.
TESS: I understand you're a new homeowner.
ANGELA: I am.
ANGELA: Thank you very much.
TESS: Well tell us what your question is for Chris today.
ANGELA: I bought the house for $590,000 but the house actually appraised at $650,000. So I put down $60,000 and then I have another $60,000 in equity if you look at the appraisal versus what I paid for it. So my question has to do with the private mortgage insurance, PMI, but I know that PMI is supposed to go away when you hit 20 percent equity.
ANGELA: So my question is -- with the $60,000 I put down plus the $60,000 that I have in equity on the house when does that PMI go away?
TESS: Chris it sounds like she should be able to go without PMI. Why do you think she has to pay it?
CHRIS: It all has to do with home appreciation. You don't need PMI if you don't put the 20-percent down, so that would be $120,000 or by paying off the loan and you pay down the loan you hit that $120,000 mark -- no PMI. The rules get squishy when it comes to treating appreciation. What we're going to do is just look at the Fannie-Mae and Freddie-Mac rules. What they say is that, first of all, any loan must be seasoned, it needs to be at least two years old before a cancellation can be based on price appreciation. So if your house appreciates over the next two years, then you can apply to your lender and say, "Hey look, you know the price has appreciated and if the loan is between two and five years old, the servicer can cancel your private mortgage insurance if a current appraisal -- an appraisal done at that time shows that it has a loan-to-value ratio of 75-percent, in other words -- including appreciation you have 25-percent equity in your home."
TESS: So basically the appraisal that she has now that says that her home is worth $650,000 it's just a piece of paper?
CHRIS: It's just a piece of paper. At this point what's going to matter is -- what's the appraised value in two years.
ANGELA: Can I refinance in six months?
CHRIS: If there's no prepayment penalty and you can refinance and put more down then you can get rid of the private mortgage insurance that way -- absolutely.
ANGELA: But would I have to put down a whole other 10-percent or wouldn't some of that equity transfer over?
CHRIS: In general no one is going to let you refinance based on price appreciation in this market at this point in time. What they're trying to do is get past the foreclosure risk which is why they want the loan to be seasoned, they want to show that you have a -- a little bit of history of payments and so you can refinance but you're not going to be able to refinance in order to get rid of the PMI, which by the way is tax-deductible.
ANGELA: Well that's a little silver lining I guess.
TESS: Thanks for the call -- good one.
ANGELA: Thanks you guys, I appreciate your show.
TESS: Take care.
TESS: All right, Chris our website as we all know is www.marketplace.org and if you've got a question just click on the Getting Personal link there or you can give us a call, we're at 877-275-6669. That's 877-ASK-MONY. Let's reach into the email bag and Jerry writes in from Portland, Oregon, my hometown. He wants to know what the difference is before a 457 Plan and a 403-B Plan, and I think we've addressed this in kind of different questions before. This is government work versus non-profit?
CHRIS: Yes, that's sort of the dividing line in general over who is offering the type of plan, but you can also have many institutions that have both retirement savings plans. You know to a large extent they're going to seem the same, I mean the maximum contribution in 2008 is $15,500, if you're over 50 you know you can make that additional $5,000 contribution. The money you put in is pre-tax money. Your gains are tax-deferred and then when you pull the money out in retirement you pay your taxes then. So the key difference is on the distribution side. There are two important differences between a 457 and a 403-B. It's easier to take out a loan, to borrow against your 403-B than it is against a 457. The second thing is let's say -- you have a 403-B right, Tess?
TESS: I do just like you.
CHRIS: So let's say I just said I'm going to take some money out -- going to take $10,000 out, I just need this money. It's called a premature withdrawal because I am under 59 and a half and so we pay ordinary income taxes on the money we -- we withdrew plus a 10-percent penalty. With the 457 you pay ordinary income taxes on the money you withdraw but there is no 10-percent penalty.
TESS: So is there any benefit to splitting up your retirement funding between a 457 and a 403-B or does he have to choose?
CHRIS: If your company offers both a 457 and a 403-B you can put $15,000 in the 457 and $15,500 into the 403-B. Now if your company happened to offer a 401-K and a 403-B you couldn't, it's the maximum of $15,500. The one exception is if your company offers a 457 and a 403-B you can put more than $15,500 into the retirement plan.
TESS: All right, well there you go Jerry. Thanks so much for writing in. Once again our phone number is 877-275-6669, that's 877-ASK-MONY where now we are also answering your questions every weekday online at www.marketplace.org. Just click on the Getting Personal link on our website and stay tuned for more Getting Personal later in the show. This is Marketplace Money from American Public Media.
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[Begin Getting Personal Part Two]
TESS: All right, Chris, we are back with Getting Personal and let's go ahead and reach right into the e-mail bag. Sasha writes in from Playa Del Ray, California -- beautiful beach town, a few years ago her parents asked her to co-sign her sister's private student loans. They couldn't do it because they had bad credit.
TESS: She was still in school at the time, didn't understand the magnitude of what she agreed to do, now she's worried because her sister isn't very good with money and her parents' credit has improved and they're willing to take over as co-signors. Can you just switch who is co-signing?
CHRIS: Well what I would is call the -- the loan company and say look, we don't want to get rid of a co-signor. We just wanted to switch co-signors and having multiple co-signors is always to the benefit of the -- of the company. Think about it this way, one reason why I'm very weary about anybody co-signing is that you are taking on this obligation if the student stops making the payments.
CHRIS: So it's a real risk here. Now most of your servicing companies have a way for co-signors to get out after a period of time. So when the sister graduates and then if it's a Sallie-Mae which is one of the big student loan lenders, the Sallie-Mae private loan, 24 consecutive payments, you know has shown good credit, everything on time, the co-signor can apply to be dropped. Another service provider I was looking at it was 48 straight payments. What is a little bit different about this one is that she's still in school and you want to get rid of one co-signor but you want to put another two co-signors into the mix. I don't see why the service provider wouldn't do it, but it is their choice. I would apply, I would call them and say this is what we want to do and then go through the paperwork. From the service provider's point of view they can say no, but they're still getting the protection that they want so I don't see why they wouldn't do it.
TESS: All right, there you go Sasha, thanks so much for writing in. And if you've got a question just visit our website, we're at www.marketplace.org. Click on the Getting Personal link there or give us a call. We're at 877-275-6669, that's 877-ASK-MONY. All right, Chris, our next caller is Kathy and she joins us from Charlotte, North Carolina -- hi, Kathy.
KATHY FROM CHARLOTTE, NORTH CAROLINA: Hi, thank you guys so much for taking my call.
TESS: Oh it's our pleasure. What is your question for Chris today?
KATHY: Well I have a 401-K Plan with my employers and two years back I took a loan from my 401-K Plan on a repayment plan to pay myself back in five years at a 9-percent rate of interest to myself. And I'm sort of wrestling with the idea of whether I should just take the remaining balance of the withdrawal at this point or to struggle through paying myself back. You know everything has gone up and I'm really starting to miss that extra income in my pay, so I guess my question -- I'm looking at it from two angles, how much am I going to be hurting myself in the long run if I just take the remaining balance as a withdrawal and what would the tax implications be for me?
TESS: Do you mind if I ask what you borrowed for?
KATHY: Yes, I borrowed $30,000 because my mother was purchasing a property and I actually gave the money to her.
TESS: Oh okay, all right, well Chris obviously if she's not going to pay herself back it is going to affect that compounding benefit that you get over time. Any idea how -- how much she might be losing out on?
CHRIS: That's the real long-term impact. Just as you put it, Tess, it's that lack of your money compounding over a long period of time and that's going to be the big hit that you take long-term. Short-term you are also going to be taking a hit and there's two forms of that -- that it comes. One is the loan is treated as in-default which is a horrible sounding word but it doesn't get reported to the -- to any of the credit reporting bureaus or anything like that. What the government says is okay, it's an early distribution. Therefore you're going -- on the remaining amount you're going to pay your ordinary income tax rate on it, plus a 10-percent penalty.
TESS: So it's just as if she had withdrawn it for no good reason?
CHRIS: For no good reason, so in other words let's say there's $20,000 left that you need to repay all right? You won't have to pay ordinary income taxes on $30,000 because you paid back $10,000, so it's on the remaining $20,000 -- considered early distribution. So your income goes up for this tax year by $20,000, you're going to pay your ordinary income taxes plus you'll pay a 10-percent penalty on top of that.
TESS: Chris, you said that it's then considered in-default, what does that mean?
CHRIS: It's really an early distribution, if you go through the literature they -- they always will be using the word default and that sets off all kinds of alarm bells and am I going to be -- is it going to be reported to the credit reporting agencies? Is it going to affect my credit score? And the answer to all of that is no, it won't.
KATHY: Since it was used for the purchase of a property aren't there certain exceptions for when you take that money and invest it in real estate or in something like that?
CHRIS: The exception that you get with real estate is the length of time to pay it back. For the typical 401-K loan you have a maximum of five years to pay it back. If you quit your job by the way that typically shifts to 60 days to pay it back. However, with purchasing a primary residence 10 to 15 years is common in terms of a payback schedule, so it's a break on the payback schedule, a little more flexibility but that's the -- the major benefit.
TESS: So what do you think Kathy? I mean given that Uncle Sam is going to want to take his chunk of it do you think you'll still stop your repayments?
KATHY: No, I'm going to suck it up and keep paying myself back. I know that I'll appreciate it in the long-term anyway I'm sure. [Laughs]
TESS: Yeah, you will appreciate it when you do decide to retire. [Laughs]
KATHY: Thank you both so much, I appreciate it.
TESS: Thanks for the question.
KATHY: All right, bye-bye.
TESS: Well unfortunately those are all the calls we can take on this week's show, but Chris is now answering your personal finance questions online every weekday. Just visit our website, it's www.marketplace.org and click on the Getting Personal link there. You can also call us at 877-275-6669, that's 877-ASK-MONY. Chris, thanks for the great advice as always.
CHRIS: Thanks, Tess.