Private Mortgage Insurance
If you are planning on buying a new home, try to save as much money as possible for the down payment. Ideally you will be able to put down at least twenty percent of the purchase price. If your down payment is less than twenty percent of the sale price, you’ll be required to obtain private
mortgage insurance (PMI) from your lender. PMI protects the lender in the event that you default on
the loan. It doesn’t protect you from anything.
How much you will pay in PMI charges will vary depending on the lender, the size of the loan, and the size of the down payment. Generally, the charge is equal to about one-half of one percent.
For example, say you bought a home for $200,000 and were only able to put down ten percent ($20,000). The loan amount would be $180,000 and the lender would calculate the PMI charge by multiplying $180,000 by 0.005. The result is an annual PMI charge of $900, which would add an additional $75 to your monthly bill.
You’ll have to pay for PMI until your equity in the home exceeds twenty percent. It can take years to pay down the principal enough to be rid of PMI. But in a market where housing prices are increasing rapidly, in can happen a lot faster. If your home appreciates to the point where your equity is over twenty percent, you can have the PMI charges dropped. Usually, you will have to pay for a home appraisal to prove that the home’s value has increased. Expect the appraisal to cost a few hundred
dollars, but you will quickly make that back by having your monthly payment reduced.
It should also be noted that while the interest you pay on your mortgage is usually tax-deductible, PMI is not.
Avoiding PMI
So what if you cannot afford to put down twenty percent and you don’t want to pay PMI? Fortunately there are a couple of options.
An “80-10-10″ loan involves taking out two mortgages. The first would be for 80 percent of the sales price and the second would be for 10 percent. The remaining 10 percent would be your down payment.
The second mortgage would have a slightly higher interest rate. But since the amount borrowed is lower, it would still be cheaper than paying one mortgage with PMI. Also, you would receive an added savings because the interest would all be tax deductible.
Another option to avoid paying PMI is to pay a higher interest rate. Many lenders will waive PMI if you agree to pay a higher rate until your equity exceeds twenty percent. Once you reach the twenty percent mark, your rate would be lowered.
The rate increase usually ranges from 0.5 to 1 percentage point. Usually the higher your down payment, the lower the increase. Again, the advantage is that the added interest is tax deductible.
