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Refinance your way out of mortgage insurance

Mortgage rates are low and home values are appreciating rapidly in much of the country -- a combination that can help homeowners get rid of mortgage insurance.

If you got a conventional home loan and made a down payment of less than 20 percent of the purchase price, you almost certainly had to pay for private mortgage insurance, or PMI. The policy reimburses your lender if you default on the mortgage.

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Another way to get rid of mortgage insurance is to ask to have your house appraised again. If the value has increased sufficiently, your current mortgage balance might be less than 80 percent of the home's new value. In other words, the amount you owe hasn't changed, but it's a lower percentage of the home's value because the value has risen.

The problem with getting your house reappraised to get rid of PMI is that it doesn't work during the first two years of the loan. Once you have to pay for mortgage insurance, you're stuck with it for two to five years, regardless of how rapidly the home's value appreciates. That's the policy of Fannie Mae and Freddie Mac, the two biggest purchasers of home loans.

Why? Because people who make down payments of less than 20 percent are riskier borrowers, regardless of how fast home values appreciate. So Fannie and Freddie require those homeowners to pay PMI for at least two years. Those who make late mortgage payments can be stuck paying for mortgage insurance for up to five years.

This is where refinancing comes in. It can be another tool to get rid of mortgage insurance.

When you refinance your mortgage, the lender obtains an appraisal. If the value has risen enough, your new loan might account for less than 80 percent of the home's current value -- and you won't have to pay for mortgage insurance.

You probably have a general idea of how much your home has appreciated in value. Even if rates haven't fallen much since you got a home loan, it might make sense to refinance if the value has increased enough to allow you to stop paying mortgage insurance. In some cases, the monthly savings from eliminating mortgage insurance could eclipse the monthly savings from getting a lower rate.

What if you're buying now instead of refinancing, and you want to avoid mortgage insurance? If your down payment is less than 20 percent, there generally is only one way to avoid PMI, and that's getting a "piggyback loan" -- a second mortgage that allows you to make what amounts to a 20 percent down payment.

For example, you would pay 10 percent down, get a first mortgage of 80 percent, and a second mortgage of 10 percent. That second mortgage -- the piggyback loan -- is always at a higher rate. You're not paying for PMI, but you're still making a monthly payment, probably for roughly the same amount as PMI.

A piggyback loan has an income tax advantage: You can deduct the interest from your taxable income. The cost of mortgage insurance isn't deductible.

 

 

 
-- Updated: Jan. 30, 2004
   

 

 
 

 

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