Mortgage Insurance

If the down payment on your home is less than 20% of its appraised value or sale price, you must obtain private mortgage insurance, known as PMI, with your lender. This will enable you to get a mortgage with a lower down payment. It's lower because your lender is now protected against default on your loan.

PMI, Private Mortgage Insurance, varies depending on the size of the down payment and the loan, but the typical amount will be about .5% of the loan. 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% of the price on a home is a lot of money. Homebuyers must maintain the PMI premiums until the balance of the loan is less than 80% of the value of the home.

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.

Note: The law does allow lenders to continue requiring PMI all the way down to 50 percent equity for so-called high-risk borrowers. 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: There are ways to get out of paying mortgage insurance even if you don't have the 20% down payment.

• Pay more interest: Some lenders will waive the mortgage insurance requirement if the buyer will accept a higher interest rate on a mortgage loan. The mortgage rate increases range from .75 percent to 1 percent, depending on the mortgage 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% loan is financed with a first mortgage equal to 80% of the sale price, and a second mortgage for the remaining 10% of the sale price. The second mortgage has a higher interest rate but it applies to only 10% of the total loan, the monthly payments on the two mortgages are generally lower than paying one mortgage with mortgage insurance. And again here 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% down payment on a $100,000 house is $10,000. The first mortgage is $80,000 at 7.5%, which comes to a monthly payment of $559. The second mortgage for $10,000 has a 9.5% 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 7.5% has a monthly payment of $629, plus PMI of $31.45, making a total payment of $660.45.