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Ask Dr. Don

Ask Dr. Don

Today, Dr. Don explains private mortgage insurance and ways to have it waived, and discusses the mortgage programs available to first-time home buyers.

Avoiding PMI

Dear Dr. Don,
We are trying to decide if we should take an 80-10-10 mortgage or put down 10 percent and pay the private mortgage insurance on a single mortgage. The 80-10-10 loans cost more monthly but all money goes toward principal and interest. The second mortgage's terms (15/30 balloon) seem rather expensive. After 15 years of payments, only a small amount of the principal is reduced. The $15,100 loan amount will only be reduced to about $12,000 and must then be paid in full or refinanced after the 15 years. It seems like a lot of interest expense to pay to avoid the PMI insurance. Is this the best route to take? I do understand that all the interest is tax-deductible, but ...
Two Bills

Dear Bill,
As an aid to uninitiated readers, the mortgage definitions page on this site defines an 80-10-10 loan as, "A combination of an 80 percent loan-to-value first mortgage, a 10 percent down payment and a 10 percent home equity loan. It would eliminate the need for private mortgage insurance, and for expensive homes it could eliminate the need for a jumbo mortgage by reducing the first mortgage to the conventional $252,700 limit ($379,050 in Alaska and Hawaii)."

There are many decision variables to consider. You can get the private mortgage insurance, or PMI, waived once you have reached 78 percent to 80 percent loan-to-value on the house, and a dollar of appreciation can be as valuable as a dollar of principal repayment in reaching that valuation. The interest expense associated with the second mortgage generates a tax deduction, while the PMI payments do not. Your after-tax cost of debt should be less for the single mortgage than it is for the first and second mortgages combined.

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Let's say you are buying your house for $151,000. With a 90 percent loan-to-value mortgage, you put $15,100 down and borrow $135,900. If housing prices increase by 5 percent a year, your house could appraise at $174,800 in just three years. Ignoring any principal repayment from your mortgage payments, you are already at 78 percent loan-to-value. To calculate the appraised value needed to drop coverage, just divide your loan balance by 80 percent. This is an aggressive approach to canceling PMI and for this approach to work your lender has to accept the appraised value of the property. You can learn more about this approach on pmirescue's Web site.

Michael Larson wrote an article for Bankrate.com on this topic, and it discusses the issues associated with the two approaches that you are considering. Use the table in the article as a framework for analyzing which approach is better for you. With a balloon mortgage as the second mortgage, and the higher payments for the 80/10/10 approach, I'd lean toward the single mortgage, especially if you think your lender will work with you when you look to cancel the PMI early from home appreciation vs. loan paydown.

First-time home buyer

Dr. Don,
I've heard about government programs where I can get a below market interest rate because I'm a first-time home buyer. Is this true? Where do I find more information about this? I heard the interest rate was about 4 percent. Please let me know because we are closing on our home soon and I would like to take advantage of this program.
Heather Highrate

Dear Heather,
Your state or local Housing Finance Agency will be able to tell you what programs are available in your area. I found mine by looking in the government section of the telephone book. Many first-time home buyer programs are targeted to low- and moderate-income families. First-time home buyer programs can be credit guarantees or reduced interest rate programs. The HFA issues tax-exempt bonds to provide below-market interest rate mortgages. Four percent mortgages wouldn't cover the cost of the tax-exempt financing, so I wouldn't hang your hat on getting that rate. Income restrictions or targeted lending areas may limit your ability to use your HFA's programs. Fannie Mae's Web site has a page that discusses the reduced rate lending programs. You also may want to check out this site's story on targeted home loans.

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Bankrate.com writers base their answers on our editorial content and advice of financial professionals. We make no claims or representations about the accuracy, timeliness or completeness of such content, advice or the answers provided to you. Our content, advice and answers are intended only to assist you with your financial decisions. However, by its nature such information is broad in scope. Your financial situation is unique, and our content, advice and answers may not be appropriate for your situation. Accordingly, we recommend that you get different opinions and seek the advice of your accountant and other financial advisers before making any final decisions or implementing any financial or investment strategy.

-- Posted: March 15, 2000

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