Private mortgage insurance: Do I have to buy it?

Richard J. Koreto

Private mortgage insurance PMI) is both necessary and misunderstood. You may find yourself having to buy it, even though you will never collect on it. Yet you might not be able to get a house without it. Many homeowners aren't clear what PMI is, when they need it and when to get rid of it. Getting a handle on PMI is essential to buying and maintaining a home.

PMI basics

Understand this first: PMI doesn't protect you and your family. Rather, it protects your lender in case you default on your mortgage - even though you're on hook for the premiums. It covers the difference between the loan balance and what the home sold for at the foreclosure sale, as well as other legal expenses, taxes and insurances you did not pay, says Frank Donnelly, president of the Mortgage Bankers Association of Metropolitan Washington.

PMI makes the mortgage industry possible, says Suzanne Hutchinson, executive vice president of the Mortgage Insurance Companies of America, an industry trade group.

"The financial strength of the private mortgage insurance industry gives it the available capacity to insure approximately 1.3 million mortgages in each of the next three years," she says.

To protect itself, your bank is likely to require you to buy PMI if you put down less than 20 percent of the home's cost as a down payment. It will probably cost you $50 to $100 a month. That extra fee may seem like a nuisance, but without PMI, you may not have a mortgage at all. If you received your mortgage through the Federal Housing Authority, your situation is a little different: You pay for a government-issued mortgage insurance with rates based on your down payment.

How long do I pay it?

So even though it's a necessary evil, are you stuck with PMI for the whole 30 years of the mortgage? Fortunately, no. Mortgage Insurance Companies of America estimates 90 percent of homeowners will be able to cancel their PMI within five years of purchasing their homes.

The key to casting off your PMI is to add equity to your home. You can do this by paying off your mortgage, or by adding value to your home.

Generally, a bank must cancel your PMI, at your request, when the amount you owe on your mortgage reaches 80 percent of the original value of the house -- assuming that you're not in default and that your house hasn't declined in value. To cancel the insurance, follow guidelines in the Homeowners Protection Act, which governs loans issued on or after July 29, 1999.

If your home has increased in value because you've made improvements or because property values have risen in your neighborhood, your equity has increased. That means you'll reach the PMI cancellation threshold more quickly than you would have if the value remained flat.

What if you forget to ask your lender to cancel your PMI? Your bank must cancel PMI automatically when your mortgage balance equals 78 percent of the original value of the house. In some high-risk situations, however, the bank can make you wait until you're halfway through the mortgage.

You'll have to make some calculations and sort through some red tape to get your PMI canceled as soon as possible. Mortgage Insurance Companies of America has a handy guide, along with a PMI cancellation calculator.

While you're stuck with PMI, the IRS gives you a break by letting you deduct it. However, the government starts phasing out the deduction when your adjusted gross income hits $100,000. The deduction disappears entirely at $109,000. Also, the deduction is set to expire at the end of 2011, meaning only premiums paid through the end of 2011 are deductible. Check IRS Publication 936 for details.

How can I avoid it?

If you can't come up with the 20 percent down payment, your only real option to avoid PMI is the so-called piggyback loan, known as a 80/10/10 or 80/15/5 loan. The bank gives you a first mortgage for 80 percent of the home's cost and an immediate second mortgage for 10 percent or 15 percent. You put up the rest in cash. This loophole -- typically reserved for those with stellar credit, but minimal capital -- lets you avoid PMI.

However, you need to make sure the interest on the second mortgage doesn't end up costing you more than PMI would have. In today's tight mortgage market, piggyback mortgages can be hard to get. But if you have good credit, it can't hurt to ask.

"They can be found on a limited basis," Donnelly says.

So, if you're paying your PMI premiums to protect your bank, what about protecting your family? In that case, you may want a mortgage life insurance policy. This policy, which is entirely separate from PMI, will pay off your mortgage if you die. Also, a standard term life insurance policy can provide the funds necessary to pay off the mortgage, often for less money. Check with your life insurance carrier for details.

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