If your down payment on a home is less than 20% of
the appraised value or purchase price, you will be required to pay
private mortgage insurance, or PMI, each month.
PMI usually amounts to about 1% of the loan amount.
You will pay the premiums each month, but you aren't the
beneficiary - the lender is. PMI protects the lender in the event
you default on the mortgage. If you stop paying, the insurance
company will pay the lender in full. While PMI premiums are usually
added onto your monthly payment, there are some lenders that allow
you to pay for it in a lump sum at closing. This helps keep your
monthly payment amount down.
If you put 10% down on a $150,000, you would be
required to purchase PMI. The lender would multiply the principal
loan amount, or $135,000, by .005%. The resulting amount, $675, is
your annual PMI premium. This is then divided into twelve monthly
payments of $56.25.
Most home buyers are not able to save 20% for the down
payment on a home. On a $150,000 home, 20% would be $30,000. But
once the principal balance has been paid down below the 80% mark,
the borrower can cancel the PMI.
Until you reach the 80% mark, you will have to keep
paying the PMI. But there are a few ways to avoid paying PMI.
Pay a higher interest rate
Some lenders will waive the PMI requirement if you are
willing to pay a higher interest rate on the mortgage. The rate
increase can be anywhere between 0.75% and 1.00%, depending on the
down payment. The benefit is that you can deduct your mortgage
interest paid, but not your mortgage insurance premiums. But you
will pay more interest over the life of the loan because of the
higher rate. It will probably cost you more in the long run.
Use a piggy-back loan
A piggy-back loan is taking out two loans to purchase
one house. The borrower is approved for a mortgage of 80% of the
sale price. He can pay 10%, leaving a 10% still to be found. A
second mortgage may be allowable that would pay the remaining 10% of
the down payment. The second mortgage will have a higher interest
rate, but will still be lower than the monthly PMI payment. Plus,
the mortgage interest paid is tax deductible in most situations.
This is also called an 80-10-10 mortgage, even though there are
other varieties, such as 80-15-5.
Let's look at the numbers in a piggy-back loan. Under
the 80-10-10, the 10% down payment is $15,000 on a $150,000 home.
The first mortgage would be for $120,000 at a 7% interest rate. The
monthly total for the first mortgage is $798.36.
The second mortgage would be for the remaining 10%, or
$15,000. It would come at a 9% interest rate and a monthly payment
of $120.69.
The total monthly payment between the two mortgages is
$919.05.
A mortgage of $135,000 with only a $15,000, or 10%,
down payment has an interest rate of 7% and a monthly payment of
$898.16. You will be required to pay PMI in the amount of $56.25
each month. The total payment would be $954.41.
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