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What is mortgage insurance?

Mortgage » Basics » What Is Mortgage Insurance?

If your down payment on a home is less than 20 percent of the appraised value or sale price, you must obtain mortgage insurance.

Mortgage insurance sometimes is referred to as private mortgage insurance, or PMI, to distinguish it from FHA and VA insurance, run by government programs. The cost of mortgage insurance varies depending on the size of the down payment and the loan, but it typically amounts to about one-half of 1 percent of the loan.

With mortgage insurance, the borrower pays the premiums, but the lender is the beneficiary. The coverage protects lenders against default by the borrower. If a borrower stops paying on a mortgage, the insurance company ensures that the lender will be paid in full.

Mortgage companies pick insurance providers for their customers, but the borrowers have to foot the bill. Usually, they do so in monthly installments. But some lenders offer programs whereby the borrower pays the entire insurance premium in a lump sum at closing.

By the numbers ... 80-10-10 plan

If we compare the purchase of a $150,000 home under the 80-10-10 plan to a standard fixed mortgage including mortgage insurance, we find that the former is $35.36 cheaper each month.

Here's how it works: Under the 80-10-10 plan, the 10 percent down payment on a $150,000 house is $15,000. The first mortgage is $120,000 at 7 percent, which comes to a monthly payment of $798.36. The second mortgage for $15,000 has a 9 percent interest rate, making a monthly payment of $120.69. The total monthly payment for both loans is $919.05.

With a $15,000 down payment, one mortgage of $135,000 at 7 percent has a monthly payment of $898.16, plus mortgage insurance of $56.25, making a total payment $954.41.

80-10-10 plan
Down payment10%$15,000
Mortgage 1$120,0007%$798.36
Mortgage 2$15,0009%$120.69
Total monthly:$919.05
Standard fixed mortgage plan
Down payment10%$15,000
Mortgage 1$135,0007%$898.16
Mortgage insurance+ $56.25
Total monthly:$919.05
Monthly difference: $35.36

How to avoid PMI

Pay more interest. Some lenders will waive the mortgage insurance requirement if the buyer accepts a higher interest rate on the mortgage loan.

The rate increase generally ranges from three-quarters of a percentage point, or 75 basis points, to a full percentage point, depending on the down payment. A basis point is one-hundredth of 1 percentage point. Borrowers can benefit from this because mortgage interest is tax-deductible, whereas mortgage insurance premiums aren't. But they'll end up paying more interest over the life of the loan because of the higher rate.

Use an 80-10-10 loan. This program involves getting two loans. The borrower gets a first mortgage equal to 80 percent of the sale price, a second mortgage for another 10 percent of the price and puts the remaining 10 percent down at closing. The second mortgage has a higher interest rate. But since it applies to 10 percent of the total loan, the monthly payments on the two mortgages can still be lower than the monthly payment on one home loan with mortgage insurance. Plus, interest on the second mortgage is tax-deductible. The 80-10-10 loan isn't the only plan available; borrowers can get 80-15-5 loans or other combinations.

Posted: April 1, 2005

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