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Since PMI (private mortgage insurance) is often required by lenders if your mortgage loan amount equals more than 80% of the fair market value (FMV) of your new home at closing, the obvious answer is to borrow only 80% or less. That is the simplest answer to give you but often the most difficult solution to use when your checking and savings accounts aren't stuffed with cash. Luckily, there are a couple of other solutions that might work for you.
One option is commonly called an “80-10-10” program, which is available from some lenders. Remember, although your mortgage lender collects your hated PMI premium, they receive only protection, not income. Therefore, numerous lenders have no problem presenting solutions that eliminate the need for PMI. If you have enough cash for a ten per cent (10%) down payment, you can borrow a first mortgage of 80% of your new home's FMV, eliminating the need for PMI. The remaining ten per cent (10%) needed to complete the purchase will come from a purchase money second mortgage, given you by your mortgage lender or another lending source. Assuming your second mortgage terms are reasonable, you will often save money every month using this approach.
Another solution, that might save you even more, is to borrow from a lender that has one or more “self-insured” first mortgage programs that fit your financing plans. You will pay a slightly higher interest rate than you would otherwise receive. Your lender then uses this extra income to insure themselves for the added risk of granting you a loan that amounts to 85% to 95% loan-to-value (LTV) based on the FMV of your new home, instead of forcing you to get PMI. If the interest rate you receive is near current market rates, you might save more money than if you used the 80-10-10 program described above.
When you consider the options to avoid PMI, also remember that if you are purchasing your new home in a period of rapidly rising prices, you might not be required to keep your PMI for very long. Another factor to consider: While a second mortgage or using a self-insured mortgage lender will result in higher interest rates, your interest paid is tax deductible, so the true cost of the higher rate will be less than you're paying based on your income tax bracket. So, as much as all home buyers dislike paying PMI, avoiding it is not always the right solution. Often it is the best course of action, but you should analyze all the choices available to you.
|Jennifer Mathes, Ph.D.|