Question: I will soon be in the market to buy my first home and had a meeting with my real estate agent. She ran some numbers based on a purchase price of $230,000 with down payments of five and ten percent. Since I don't have enough money for a 20 percent down payment, she says I have to pay Private Mortgage Insurance. This jacks up my payment considerably. Surely there's a way to get rid of this. Any suggestions would be helpful.
Answer: Nobody pays private mortgage insurance, or PMI, anymore. Thanks to fierce competition in the mortgage industry, there are ways to avoid PMI even with only five percent down.
First let me explain PMI. One of the most important factors in determining whether a loan application gets approved is the amount of loan in relation to the value of the property. Lenders like a big down payment because the house acts as collateral for the loan. A large down payment means that the collateral securing the loan is worth much more than the loan amount itself.
If the first trust loan exceeds 80 percent of the purchase price, lenders get nervous and will charge PMI. PMI is a monthly premium that's attached to the monthly payment. An outside insurance company actually insures a percentage of equity in the home for the lender. This reduces the lender's exposure to the same level as if the borrower put down 20 or 25 percent. The problem with PMI is that the borrower pays for it every month and the lender receives the benefit. It does nothing for the homeowner. PMI premiums aren't even tax deductible.
The best way to avoid PMI is to break up your loan amount into two separate loans. Known as an "80-10-10" or "80-15-5", this means that you would obtain an 80 percent first trust and a ten or 15 percent second trust. You would then put down either ten or five percent in cash. Since the first trust is limited to 80 percent, PMI is not charged.
Let's use your example to illustrate why a "piggy-back" loan structure is favorable. With a ten percent down payment, you would obtain a first trust of $184,000 and a 2nd trust of $23,000. A 30 year fixed rate loan for $184,000 might cost 6.75 percent, resulting in a principal and interest (P&I) payment of $1,187. The rate on the 2nd trust will be a little higher - perhaps eight percent. The P&I payment on a $23,000 loan at eight percent is $168 per month. Both of these payments together total $1,355.
Now let's compare this to one loan with PMI. A 90 percent loan in the amount of $207,000 will cost $1,335 per month. Because the 1st trust exceeds 80 percent the bank will charge somewhere around $90 as a PMI premium. The total payment with PMI is $1,425 - $70 more that the "80-10-10" piggyback option.
After taking into consideration that PMI isn't tax deductible but the extra interest that you pay on the 2nd trust is, the difference becomes more apparent.
You can follow the same logic if you only put five percent down. The interest rate on the 2nd trust might be a bit higher, but the PMI premium on a 95 percent loan increases as well.
So there you have it. Get PMI out of your mind. Consult with a good loan officer and ask about these combo loans in order to make PMI go away.
Published: February 27, 2002
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