How can I avoid private mortgage insurance

In addition to putting 20% down, there are two other ways to avoid purchasing private mortgage insurance (PMI). One way is to pay a higher interest rate in lieu of PMI. When a borrower accepts this option, the lender buys PMI for less than the borrower would have to pay. The higher interest rate covers the insurance cost to the lender plus a profit margin. Some but not all lenders offer this option.

The sales pitch for the higher rate as a replacement for PMI is that interest is tax deductible whereas PMI premiums are not. The other side of the coin, however, is that you must pay the higher interest for the life of your mortgage, while mortgage insurance will be terminated at some point.

On most loans closed after July 29, 1999, mortgage insurance must be cancelled at the borrower's request if the loan balance is paid down to 80 percent of the original property value. Further, insurance must be terminated automatically when the balance reaches 78% of the original value. In addition, subject to certain conditions, PMI on loans sold by lenders to the two federal agencies (Fannie Mae and Freddie Mac) must be cancelled when the loan balance reaches 80% of the current property value, taking account of appreciation.

In general, if you expect significant appreciation and monitor your property value so you can terminate PMI as soon as possible, the higher interest rate option is a poor choice—unless you expect to hold the mortgage a very short time. In other cases, it could be a good choice.

You can use calculator 14a at www.mtgprofessor. com to determine whether the higher rate or PMI results in a lower cost in your particular case.

The second way to avoid paying for PMI is to take a first mortgage for 80% of value, and a second mortgage for 10% or 15%. These are known as 80/10/10s and 80/15/5s, where the last number is the down payment.

In general, combination loans are more attractive the higher your tax bracket, the smaller the difference in rate between the two mortgages, and the shorter the term of the higher-rate second. Expected rapid price appreciation reduces the attractiveness of combination loans because it means that mortgage insurance will terminate sooner.

Calculator 13a at www.mtgprofessor.com pulls together these and other relevant factors, calculating the costs of both options over the period you expect to be in your house. It also shows the "break-even rate" on the second mortgage, which is the highest rate it makes sense to pay. The combination will save you money if the market rate on the second is below the break-even rate.

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