By Jim Cramer
Many home buyers find it difficult to provide the required 20% down payment and are forced to pay private mortgage insurance, or PMI, in order to buy a home. Private mortgage insurance solves the down payment problem but creates another two: it increases monthly payments and on top of that it is not tax deductible. Fortunately, there is more than one way to get your desired home without having the 20% down payment and avoid PMI at the same time.
Terminating PMI When You Already Have One
The use of private mortgage insurance has been a great way to make it possible for a borrower to buy a home with as little as 3-5 % down payment and give the lender insurance in case the borrower defaults on the home loan. However since PMI payments can be significant, the borrower starts to ask himself/herself how to get rid of those payments.
The Homeowner's Protection Act includes rules for automatic suspension of PMI payments and cancellation of PMI when 22% equity in the borrower's home is reached. Those rules apply to mortgages signed on or after July 29, 1999, and exclude government-insured FHA or VA mortgages that are considered high-risk to default.
Additionally, disregarding the time when the mortgage was signed, the borrower may ask for PMI termination once s/he exceeds 20% equity.
Avoiding Private Mortgage Insurance via a Piggyback Loan
Piggyback loans are a very popular way of avoiding private mortgage insurance. It consists of taking a loan (first mortgage) covering 80% of the sale price of the home and taking and placing additional 5%, 10% or 15% on a second mortgage. A combination of 80% first mortgage, 5% second mortgage and 15% down payment is referred to as 80/5/15. Accordingly, the other two loan combinations are 80/10/10 and 80/15/5.
Although second mortgages generally have higher rates, in the end the borrower may save money because in contrast to PMI payments, now the loan payments are tax deductible.
Choosing a Finance Single Premium Option over Private Mortgage Insurance
Since an increasing number of borrowers are turning to piggyback loans in order to avoid PMI, the mortgage insurance industry came up with this solution claiming that it lowers monthly mortgage payments to the same or lower level as a piggyback loan. With this option homebuyers pay a single premium on their insurance and it is amortized over the term of loan.
One of the pitfalls of this solution is that few lenders offer this option, since Fannie Mae and Freddie Mac do not work with this kind of PMI structure.
Finding a Loan with No Private Mortgage Insurance
Loans with no PMI have one great disadvantage - they typically have higher interest rates. Instead of paying regular PMI, the latter is included in the higher rate of the mortgage.
Which of the above solutions will be best for you depends entirely on your particular case. Sometimes paying the private mortgage insurance might turn out more beneficial than choosing to avoid it with a second mortgage. Therefore you should consider your decision carefully and make all the necessary calculations in order to make the right choice.
Jim Cramer is an expert who shares his knowledge and years of experience in the mortgage field providing hundreds of Mortgage Questions and Mortgage Answers dedicated to help home buyers. Learn more about Home Mortgage Insurance.
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