||Ask Dr. Don
Should I pay PMI?
Dear Dr. Don,
We are planning to buy a one-family house for $267,000. We can't
make a 20-percent down payment to avoid paying PMI. We are able
to put down $26,000. Do you feel that we would be on a suicide mission
if we go forward with this deal? We are not locked in on a rate
either. The wife wants the house; I feel shaky.
Putting 10 percent down and paying private mortgage insurance isn't
the end of the world. Homeowners hate paying PMI because they're
paying insurance premiums on a policy that protects the lender,
but these policies give people access to credit that might not be
available without the insurance.
Thanks to the Homeowners Protection Act of 1998, lenders
have to cancel PMI policies on new mortgages when the loan-to-original-value
is less than or equal to 78 percent. Homeowners can also petition
for the policy to be canceled when the loan-to-original-value is
at 80 percent or less.
This law isn't perfect. For example, it doesn't require
lenders to consider any appreciation in the home's appraised value
when calculating the loan-to-value ratio for insurance purposes.
But it stops the egregious dawdling practiced by some lenders concerning
policy cancellations. See this Bankrate
feature for a thorough review of the act's provisions.
An alternative to paying PMI in your situation is
to take out a second mortgage concurrently with closing on your
first mortgage. Commonly referred to as an 80-10-10
mortgage, or a 75-15-10 mortgage, this financing structure allows
you to avoid PMI because the first mortgage doesn't exceed the 80
percent loan-to-value limit that triggers the PMI requirement.
The second mortgage typically carries a higher interest
rate than the first mortgage, but the monthly mortgage payments
include interest expense, which may be tax deductible, and repaying
the principal balance -- instead of paying insurance premiums.
Another alternative is to finance using a self-insured
mortgage. A self-insured mortgage refers to the lender accepting
the additional risk of a high loan-to-value and increasing the interest
rate on the loan instead of charging you PMI. The interest rate
will typically be half a percent higher than the insured mortgage
If you can use the interest expense deduction on your
taxes, the self-insured mortgage gives you a larger tax deduction
than an insured mortgage because PMI payments don't generate a tax
Sometimes a self-insured loan is structured to roll
down that half percentage point after the loan-to-value drops below
80 percent. That's advantageous because you're able to realize the
lower interest rate without having to refinance the loan.
The bottom line is that not having the 20 percent
for a down payment isn't a good reason not to buy the house. If
it takes you two years to save another $26,000 and housing prices
are increasing in your market by 5 percent annually, this house
will cost $294,368, and you still won't have 20 percent to put down
on the house.
-- Posted: Dec. 19, 2001