Anyone buying a home where the loan to value ratio is more than 80% requires Private Mortgage Insurance (PMI). In some cases where there is a cash-out transaction and the transaction is a 75% loan to value ratio, PMI is required. For example, if the house you bought is valued at $100,000.00 and your down payment is less than $20,000.00 you will need to carry PMI. For most expensive purchases some kind of insurance is a requirement.
The PMI is required because the lender is risking capital which must be insured in case of a default by the borrower on the loan. Statistics show that a borrower who makes a down payment of less than 20% is more likely to default on the loan, hence the lender’s requirement of the PMI. If this guarantee is not met the lender would not make the loan. While this financing arrangement may allow you to get a lower interest rate loan, the PMI addition may not really save you money in the long run.
As a borrower, PMI sould be a concern because the PMI is not tax deductible while the mortgage interest is tax deductible. So, this is an item you may want to dispose of as early as you can.
When the loan to value has fallen below 80% based on your payment history and mortgage balance on the loan, it may be time to stop the PMI. It is your responsibility to keep track of your payments so that when you meet this target you can discontinue the PMI. The lender may not advise you about this. You can review your most recent mortgage statements and divide the remaining principal balance by the original purchase price of our home to determine whether you have met the requirement.
It may be surprising to you that within a short time after you purchased the home you could discontinue the PMI. The reason is that the value of the home may have appreciated because of market forces. However, the lender may require a full appraisal of the home that typically cost about $300.00 but this can be recovered very quickly as you would not be paying the Mortgage Insurance Premium (MIP) anymore. The difference will go in your pocket and you can save this for the maintenance and upkeep expenses of the property. You can also reduce you principal balance by paying a little more every month to qualify for the removal of the PMI, as this action will reduce the loan to value ratio.
However, the Private Mortgage Insurance and the lower than 20% down payment requirements can be avoided. A lender can arrange a “80/10/10” loan for the borrower. This means that instead of one loan you will get two loans. You will get a first mortgage of 80% of the home’s value and also a second mortgage of 10% of the home’s value as well. Then, you will make a 10% down payment on the purchase. In some cases a lender may offer an "80/15/5" loan. This may seem a little odd since you are borrowing the same amount of money. However, to the lender the “first position” is only 80% of the entire amount and represents less risk than if the full amount was considered. By doing this, you will make a small down payment and get the tax deductible interest. These are acceptable financing strategies in the lending industry. As an additional benefit, you get a lower total monthly payment on the loan since you would not have a very large loan with the PMI payments.
Another alternative is to allow the lender to build the PMI into the interest rate. You must agree to pay the higher interest rate as the lender would be loaning you more money than usual. This arrangement can be seen as a benefit to the borrower too as the interest is still tax deductible. This may also be seen as a simpler method than to two loan strategy. But, all in all, you must make comparisons to ensure you are maximizing your funding with little downside risks.
You can call you mortgage insurance professional and get their advice for assessing all possibilities for getting the right combination of financing strategies that will work in your favor.
These strategies described here apply for conventional loans only. Federal Home Administration loans have MIP that are required to be kept for the life of the loan.
Now you can talk to your mortgage insurance professional with more confidence about getting the right private mortgage loan for your next home purchase!