Private mortgage insurance, or PMI, is generally a requirement for home buyers who do not have a down payment of at least 20% of the home's value. This insurance protects the lender and covers the lenders cost if the borrower was to default on the mortgage. For many first time homeowners PMI is the only option, but lenders have come up with creative ways avoid PMI.
In some circumstances PMI can be avoided by using something called a piggy back mortgage where a borrower has one loan for 80% of the purchase price and another loan for the remaining 20%. This second mortgage generally has a much higher interest rate and can be an adjustable rate loan. There is also a hybrid form of this strategy where a borrower has a down payment of 5% making the second loan on 15% and the first loan 80%. With the piggy back mortgage, borrowers were able to deduct the interest from both loans on their federal and state income taxes.
If you are currently paying PMI, it can be difficult to cancel. Federal law requires that a lender cancel the PMI insurance once the balance on the load reaches 78% of the original loan value. This law does not apply to FHA loans, in which the borrower pays PMI for the life of the loan. PMI can also be canceled if the value of the property appreciates enough that the loan balance is only 80% of the property value. In this instance, the borrower would need to contact the lender and request that PMI be canceled based on the appreciation of the property. Many times, the borrower is required to pay for an appraisal of the property to determine if the value is enough to cancel the insurance.
Since 2007, borrowers who itemize their federal taxes can deduct the cost of PMI. This only applies to mortgages originated after 2007 and excludes mortgages made prior to that date. The ability to deduct PMI has made the piggy back mortgage much less common since the tax incentive of deducting PMI is a more attractive option than the higher interest second mortgage.