Let’s assume that the price of a home is $ 300,000 and the loan amount is $ 270,000 (meaning the borrower made a $ 30,000 down payment) and the LTV ratio is 90%. Depending on the type of mortgage, the monthly PMI payment would be between $ 117 to $ 150. Adjustable rate mortgages (ARM) require higher PMI payments than fixed rate mortgages. (For more information about arms, see armed and dangerous or mortgages. Fixed-Rate Versus Adjustable Rate)
However, PMI is not necessarily a permanent requirement. Lenders are required to drop PMI when LTV ratio of a mortgage of 78% through a combination of key off the mortgage and home price appreciation reached. As part of the reduction in the LTV ratio is achieved by home price appreciation, a new appraisal, paid by the borrower will check required in view of the amount of appreciation. (For more information about PMI, see Six Reasons to Avoid Private Mortgage Insurance and You Will Break Even in your house?)
easy way out
An alternative to paying PMI is to use a second mortgage or piggyback loan. In addition, the borrower takes a first mortgage to avoid an amount equal to 80% of the home value, thus PMI, and then take a second mortgage with an amount equal to the sales price of the home minus the amount of the deposit and the amount of the first mortgage. Using the numbers from the above example, the borrower would take a first mortgage for $ 240,000, make a $ 30,000 down payment and get a second mortgage for $ 30,000. The borrower is no longer required to pay PMI because the LTV ratio of the first mortgage is 80%, but the borrower now has a second mortgage that higher interest rates will carry out the first mortgage in most cases. There are many types of second mortgages available, but the higher interest rate is still par for the course. However, the combined payments of the first and second mortgage is usually less than the payment of the first mortgage plus PMI.
When it comes to PMI, a borrower who is less than 20% of the sales price or put the value of a home as a down payment have two options:
Use a “stand-alone” first mortgage and pay PMI until the LTV of the mortgage 78%, at which point the PMI can be reached eliminated.
Use a second mortgage. This will likely result in lower initial mortgage costs than paying PMI, but at the same time, a second mortgage carries a higher interest rate than the first mortgage, and can only be removed by paying it off or refinancing of both the first if the second mortgage into a new stand-alone mortgage, presumably when the LTV reaches 80% or lower (not PMI will be required).
There are several variables that can play into this decision, including:
The tax savings associated with the PMI verses paying the tax savings associated with paying interest on a second mortgage. Tax law in the United States allows for the deduction of the PMI for specific income levels, including families earning less than $ 100,000.
The cost of eliminating a new rating for PMI with respect to the cost of refinancing of a first and second mortgage in a single stand-alone mortgage.
The risk that rising interest rates between the time of the first mortgage decision and when the first and second mortgages would be refinanced.
The differences in the strongest decline in two options.
The time value of money. (Explore this issue further in the concept of the time value of money.)
The most important variable in the decision:
The expected rate of home price appreciation
For example, if the borrower chooses to use a stand-alone first mortgage and pay PMI versus using eliminate a second mortgage PMI, how quickly the house value at the point to where the LTV is 78% and the PMI can be canceled? This is the crucial deciding factor. For simplification, and the purposes of this discussion, we’re going to ignore the other variables above, as appreciation dominates it.
Rating: The Key to decision-making
The key to the decision is that once PMI is eliminated from the stand-alone first mortgage, the monthly payment will be lower than the combined payments on the first and second mortgages. So we ask the questions: “How long will it take before PMI can be removed” and? “What are the savings associated with each option?”
Below are two examples based on different estimates of the rate of home price appreciation.
Example 1: a low rate of Interior Price Rating
The following tables compare the monthly payments of a stand-alone, 30-year fixed rate mortgage with PMI compared to a 30-year fixed rate first mortgage combined with a 30-year / due-in-15-year second mortgage.