If your down payment on a home is less than 20 percent of the appraised value or sale price,
you must obtain private mortgage insurance, known as PMI, with your lender. This will enable
you to obtain a mortgage with a lower down payment because your lender is now protected
against any default on the loan.
PMI charges vary depending on the size of the down payment and the loan, but they typically
amount to about one-half of one percent of the loan, according to the Mortgage Bankers
Association of America. Mortgage insurance premiums are not tax deductible.
Example
Let's say you put down 10 percent or $10,000 on a $100,000 house. The lender multiplies the
90 percent loan, or $90,000, by .005 percent. The result is an annual PMI of $450, which is
divided into monthly payments of $37.50.
Most homebuyers need PMI because 20 percent of the sale price on a home is a lot of money;
for instance, that's $20,000 on a $100,000 home. Homebuyers must maintain the PMI premiums
until they cross that one-fifth-of-principal threshold, a process that can take years in
longer-term mortgages.
Tip
Keep track of your payments on the principal of the mortgage. When you reach 80 percent
equity, notify the lender that it is time to discontinue the PMI premiums. A new law that
takes effect in the summer of 1999 will require lenders to tell the buyer at closing how
many years and months it will take for them to pay 20 percent of the principal to cancel
PMI.
Note: The law does allow lenders to continue requiring PMI all the way down to 50 percent
equity for so-called high-risk borrowers. Traditionally, those loans that are considered
riskier include reduced documentation loans, in which customers provide less proof of income
and other information during the approval process. Loans for people with spotty credit
histories and higher debt-to-income ratios also fall into this category. Additionally,
some FHA loans require payment of PMI throughout the entire life of the loan.
Ways to Avoid PMI
In today's market, there are some new ways to avoid mortgage insurance even when you don't
have the standard 20 percent down payment.
Pay more interest: Some lenders will waive the mortgage insurance requirement if the
buyer accepts a higher interest rate on the mortgage loan. The rate increases generally
range from .75 percent to 1 percent, depending on the down payment. The advantage is that
mortgage interest is tax deductible.
Using an "80-10-10" loan:This program involves two loans and a 10 percent down
payment. The 90 percent loan is financed with a first mortgage equal to 80 percent of the
sale price, and a second mortgage for the remaining 10 percent of the sale price. The second
mortgage has a higher interest rate but since it applies to only 10 percent of the total
loan, the monthly payments on the two mortgages are still lower than paying one mortgage
with mortgage insurance. Plus, again, there is the advantage of mortgage interest being tax
deductible.
Example
If we compare the purchase of a $100,000 home under the "80-10-10" plan with a standard
fixed mortgage including PMI, we find that the former is $17.45 cheaper each month.
Here's how it works. Under the "80-10-10" plan, the 10 percent down payment on a $100,000
house is $10,000. The first mortgage is $80,000 at 7.50 percent, which comes
to a monthly payment of $559. The second mortgage for $10,000 has a 9.50 percent interest
rate, making a monthly payment of $84. Total monthly payments of the two loans:
$643.
With a $10,000 down payment, one mortgage of $90,000 at 7.50 percent has a monthly
payment of $629, plus PMI of $31.45, making a total payment of $660.45.