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Getting rid of private mortgage insurance early

Lower rates are not the only reason to refinance a mortgage. Some homeowners can eliminate private mortgage insurance by refinancing their loans -- even if they continue to owe more than 80 percent of the value of the house.

To pull off this feat, you have to be good, lucky and persistent. You have to be good because you can't avoid private mortgage insurance unless you have a spotless mortgage payment history; lucky because you'll have to fit a certain profile of borrower; persistent because you'll have to shop around to find a lender that keeps mortgage loans on its books and is willing to take a risk on you.

There are other ways to avoid paying private mortgage insurance, or PMI. The most common method is to get a "piggyback loan." But for homeowners who owe between 80 percent and about 83 percent of the house's value, there's another way to avoid PMI when refinancing the loan: Find a cooperative and flexible lender that won't immediately sell the mortgage on the secondary market.

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About PMI
Private mortgage insurance protects the lender from the expense of foreclosing on the property if you default. If you buy a house with a conventional mortgage and you make a down payment of less than 20 percent, you're almost always required to get PMI.

The insurance benefits the lender, but the borrower pays for it.

The cost of PMI varies depending upon the size of the mortgage and the percentage of the down payment. If you made a down payment of more than 15 percent but less than 20 percent, you'll pay about 0.32 percent of your loan amount annually in PMI premiums. That's about $40 a month for a $150,000 mortgage.

When you're buying a house with a conventional mortgage, there's not much you can do to avoid paying for PMI if you make a down payment of less than 20 percent. About the only option is to get a piggyback loan -- a second mortgage that allows you to make 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. You can't deduct the cost of PMI.

Giving a break
When you buy a house with less than 20 percent down and with a conventional mortgage, the lender is almost always going to make you pay somehow -- either PMI or a piggyback loan. But when you're refinancing, you might be able to avoid them both if you find the right lender.

The problem is finding that lender -- one that will hold your loan in its portfolio for at least a year. You might not be able to find one. Your best bet is to ask savings and loan institutions and credit unions if they underwrite any mortgage loans that they keep in their portfolio.

"They have a certain portion that they're willing to finance on their own behalf for the upcoming year, and they say, 'Yeah, we won't charge for mortgage insurance,'" says Neil Cribb, president of Mortgage Financial Network in Safety Harbor, Fla.

Cribb says borrowers often ask him if he will give them a break on PMI, but he doesn't because his company doesn't keep mortgage loans on the books. Instead, it sells them.

The secondary market
Most mortgage lenders don't hold loans for long. They bundle mortgages together and sell them to large investors. Large pools of mortgage loans are sold and resold to big banks, insurance companies, pension funds and institutions, such as the Federal National Mortgage Association, known as Fannie Mae.

Lenders sell their mortgages to free up money to lend again, repeating the cycle over and over. This means that the original lender gets most of its money (and profit) from fees and the sale of the loan -- not from interest. The investors who buy pools of loans ultimately earn the interest that borrowers pay.

Pools of mortgage loans are a commodity, like coal. If you bought a trainload of coal, you would buy it with the understanding that it's a certain grade and type. Similarly, if you bought a bundle of millions of dollars worth of mortgages, you would buy it with the understanding that each loan has a similar degree of risk.

That's where PMI comes in. Investors want some assurance that their bundles of loans won't go bad. Since homeowners who put less than 20 percent down are more likely to default, investors insist that those loans have private mortgage insurance. Otherwise, those loans aren't marketable.

"If you fall over a penny over 80 percent, you've got to do something about the PMI issue," says Richard Brooks, general partner for First Southeast Mortgage in Birmingham, Ala., which doesn't do portfolio loans.

There's an exception to this rule: "seasoned" loans. These are mortgages in which the borrower has made payments on time for a year or more. Seasoned loans can be bundled with other mortgages and sold on the secondary market, even if they don't have PMI.

Hard to find
So the trick is finding a portfolio lender that will waive the PMI requirement and hold the loan for at least a year, when it can sell the loan on the secondary market. Experts say it takes a certain kind of borrower to get a break like this:

  • Usually, the borrower is refinancing a mortgage and has had no late payments in the last year or two.

  • The borrower is just barely over the 80-percent PMI threshold. Someone who owes $85,000 on a $100,000 house probably won't get a break on PMI, but someone who owes $82,000 might.

  • The borrower is otherwise creditworthy -- has a high credit score, has a stable job, has a good ratio of income to debt.

The problem is that it's not easy to find a portfolio lender. You have to call around or ask a mortgage broker to find one.

-- Posted: March 15, 2004
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