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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.
Kevin Knight

Dear Kevin,
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.

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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 loan.

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 deduction.

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

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See Also
Getting rid of PMI
80-10-10 plans with jumbo mortgages
PMI vs. a self-insured mortgage?

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