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A primer on PMI
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December 28, 2000: 7:06 a.m. ET
Put down less than 20%, and you need private mortgage insurance. Or do you?
By Staff Writer Alex Frew McMillan
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NEW YORK (CNNfn) - It hits once a month like clockwork, an unpleasant queasy feeling that leaves you all headachey. It's PMI.
Private mortgage insurance is typically required when a home buyer puts down less than 20 percent of the value to buy a house. It protects the lender in case the homeowner defaults on the mortgage.
But there are alternatives, too. As the home-loan industry has become more competitive, mortgage experts say it pays to shop around and check your math. There could be a better deal out there for you.
Getting borrowers into bigger homes, quicker
PMI serves an important purpose. After a default, there's a foreclosure. The bank has to arrange to sell the house.
Sometimes the house has declined in value - it's in bad shape, or the real-estate market has turned for the worse. There are also closing costs, delinquency costs, eviction costs and costs to repair and sell the house. The insurance covers the lender for the difference between the sale price and the lender's cost.
 On the plus side for prospective buyers, private mortgage insurance helps people get into a bigger home, faster.
"The key to private mortgage insurance is, it lets you pay, obviously, less money down -- the idea being, you can move into a home sooner than you otherwise might," explained Jeff Lubar, spokesman for the Mortgage Insurance Companies of America, which represents the PMI industry.
But it adds to the cost of a mortgage. Both Freddie Mac and Fannie Mae, which back mortgages, require private mortgage insurance on loans they buy. Even if you don't get a loan backed by either company, almost all lenders require PMI.
"It's a risk issue," Freddie Mac spokesman Brad German said. "If there's a shortfall, the mortgage insurer steps in and pays that difference."
Government-backed loans such as those offered by the Federal Housing Administration and the Department of Veterans Affairs don't require PMI. By definition, PMI only applies to mortgages in the private sector, and the United States is providing the guarantee on FHA and VA loans.
But homeowners with government-backed loans do pay similar sorts of insurance - a mortgage insurance premium in the case of FHA loans, and a funding fee with VA loans.
Lenders required to cancel PMI on new loans
In the late '90s, mortgage companies came under fire for not canceling private mortgage insurance even when homeowners no longer needed it.
Last year, the Homeownership & Equity Protection Act went into effect requiring lenders to cancel PMI when the loan-to-value ratio, or LTV, hits 78 percent. The law also requires lenders to cancel PMI at 80 percent LTV if the customer requests it. At that point, the risk of default is low enough that the homeowner doesn't need the insurance.
 Thirdly, borrowers are required to cancel PMI at the half point of the loan. That would be unusual - a homeowner would almost always hit 78 percent LTV first. But "midpoint cancellation" could happen if a homebuyer financed close to 100 percent of a house at a high rate of interest.
The act only applies to loans originated after July 29, 1999, the date it went into effect. But homeowners with older mortgages can still request PMI cancellation at 80 percent LTV.
Appreciation doesn't count - LTV figures only the amount a homeowner has paid on the mortgage. But in fact Fannie Mae and Freddie Mac will normally allow a lender to figure in appreciation to cancel PMI.
Remember, though, that the lender controls the appraisal. The No. 1 mistake consumers make, according to Vicki Vidal, director of loan administration for the Mortgage Bankers Association of America, is to run out and pay for their own appraisal.
"The lender controls the appraisal -- don't bother getting your own," Vidal said. Otherwise you'll likely just end up paying for an appraisal that the lender won't use, she said.
Alternatives to PMI
Borrowers also offer ways around PMI. Most of the products were developed in the mid to late '90s, after thrifts lost their dominance in home loans.
"There's always someone out there offering borrowers anything they want to buy," Vidal said.
"You have a lot of lenders in the country, and so innovation is what they do," agreed Sam Pincich, regulatory counsel with America's Community Bankers. "It's like talking about automobiles: the Chevy has this, and the Ford has that."
 The most common alternative to PMI is an 80-10-10 loan, or a "piggyback" loan. The homebuyer makes a downpayment of 10 percent of the home's price, then borrows 80 percent on a first mortgage and immediately takes out a second mortgage for 10 percent of the value.
Mortgage lenders say they occasionally come across slight variations of that strategy - an 80-15-5 or a 90-5-5. But the 80-10-10 is the most common piggyback loan.
Effectively, the homeowner is "paying" mortgage insurance by having a higher rate on a riskier loan. The second mortgage will have a higher interest rate.
If the first 80 percent of the home is financed at 8 percent interest, say, the second 10 percent mortgage would likely run around 10 or 11 percent.
A drawback, and an advantage
There's a drawback. While a homeowner with PMI can cancel it when they hit 80 percent loan-to-value on their mortgage, a homeowner with a piggyback loan can't cancel the second mortgage.
The only way to "cancel" the second mortgage is to pay it off. But that, Vidal said, might make sense if you plan to speed up your payments on your mortgage anyway.
Where there's a drawback, there's an advantage, too. PMI payments aren't tax-deductible. But mortgage-interest payments are. So if you're itemizing on your taxes, you can deduct the interest on the second mortgage. So the higher interest you're paying to cover the insurance becomes tax deductible.
Effectively, with the interest on the second mortgage, "you're paying with before-tax dollars" for the insurance, Pincich said. The saving depends on your tax bracket, but assuming you're in the 30 percent tax bracket, you'd be saving 30 percent over what you would have paid for PMI.
Option 2: lender-paid mortgage insurance
Pay it off quickly, and a piggyback loan could prove cheaper, Vidal said. Drag out the payments, and PMI would likely have been a better option. "You can work it out on a piece of paper," she said.
The Mortgage Bankers Association has a series of calculators on its site to help you with the math. The Mortgage Insurance Companies of America also has a series of PMI-related calculators on its site. CNNfn.com's Home & Auto page also has a series of tools to help homebuyers figure out their mortgage.
There's a second option beyond a piggyback loan: lender-paid mortgage insurance.
 In lender-paid mortgage insurance, or LPMI, the borrower doesn't make mortgage insurance payments. But the borrower "pays" for the insurance with a higher rate on the mortgage.
The mortgage company typically charges a quarter point to a half point more on an LPMI mortgage over the rate they give a buyer who puts down more than 20 percent.
Where a regular mortgage might be at 8 percent, an LPMI mortgage might rise to 8.5 percent. In basic terms, the lender then takes the extra payments and buys its own mortgage insurance.
So the insurance is there - the borrower just doesn't see it. LPMI has the same drawbacks and advantages as an 80-10-10 loan. The homeowner can't cancel the higher mortgage rate. But the homeowner can deduct more mortgage interest on his or her taxes.
Ask around, planners say - and ask yourself
When it comes to mortgage insurance, Diane Rolfsmeyer, a certified financial planner in Lincoln, Neb., tells her clients to shop around.
"First of all, the client must go to several banks and discuss (PMI) with them until they're able to find a bank that is willing not to force the issue," she said.
That certainly doesn't always work - often clients just have to bite the bullet and pay the PMI, Rolfsmeyer said. But she said she's also seen clients successfully negotiate out of PMI.
"My motto is, it's possible to do just about everything if you're willing to negotiate or walk away," she said. Mortgage lenders face pressure from the Internet and sites like LendingTree.com, which offers access to mortgages online. So shop around, she recommends.
The most obvious way to avoid paying private mortgage insurance, of course, is to put down more than 20 percent on your home. That's what Jon Duncan, a certified financial planner in Tacoma, Wash., always recommends.
Typically, he said, people who end up paying PMI are buying a bigger home than they can really afford. "They're overextending themselves," Duncan said. "There's a lot of people sitting out there with a negative equity as a result." 
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