Private Mortgage Insurance (PMI)
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
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
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.
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.
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.
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
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.
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.