Mortgage Guide

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, which are 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 the borrower's default. 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...

Say you put down 10 percent or $15,000 on a $150,000 house. The lender multiplies the 90 percent loan, or $135,000, by .005 percent. The result is an annual mortgage insurance premium of $675, which is divided into monthly payments of $56.25. Most home buyers need mortgage insurance because 20 percent of the sale price on a home is a lot of money; for instance, that's $30,000 on a $150,000 home. Home buyers must maintain the premiums until they cross that one-fifth-of-principal threshold, a process that can take years in longer-term mortgages.

Strategies for avoiding mortgage insurance

A home buyer has to keep paying mortgage insurance premiums until the principal balance is paid down to a certain percentage of the home's original value. There are a couple of ways to avoid mortgage insurance. Each has its own benefits and drawbacks.

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. 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 lives of their loans due to the higher rates.

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.

By the numbers ...

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.