How to avoid private mortgage insurance (PMI)

As most home buyers may have already figured out for themselves, the easiest way to avoid mortgage insurance is to make a down payment of 20% or more on a home.  

However many potential home buyers often overlook other potential sources of additional cash than a checking or savings account.  These sources include:

• Borrowing against a 401K retirement plan

• Taking a margin loan against stock

• Asking a relative for a gift

• Refinancing a car or other asset to pull cash out

• Selling a car, jewelry, or other asset 

If a home buyer is unable to make a 20% down payment, there are other options to consider.  They include:

Lender Paid PMI:  Lender paid PMI is a program where the lender pays the mortgage insurance premium.  The catch is that the interest rate is higher than normal (ranging from 0.75% to 1.5% higher) thus translating into a higher mortgage payment.  However, the overall net effect is minimal when the buyer compares the higher payment to a lower payment with mortgage insurance.  The main advantage is that there is a larger tax deduction for the home owner because the mortgage insurance is wrapped into a higher interest rate and thus more interest is paid on the loan.  The disadvantage is that the home buyer has a higher interest rate.  Had he/she opted to pay the mortgage insurance separately, he/she could cancel it when there is a 20% to 25% equity margin in the property.

Second Mortgages:  In some cases, the home buyer may compensate 10% to 15% of the down payment for a second loan which allows the home buyer to avoid mortgage insurance.  Second mortgages may come from the lender, the seller, or even a relative or family member.  The most common scenarios are as follows:

• 80/10/10:  The borrower applies for a first mortgage for 80% of the purchase price, a second mortgage for 10% of the purchase price and makes a 10% down payment

• 80/15/5: 80% first mortgage, 15% second mortgage and a 5% down payment

• 80/20/0: 80% first mortgage, 20% second mortgage and no down payment

It is important to mention that the second loan will result in a higher interest rate and the overall payment may be marginally less than a loan with mortgage insurance.  However, the interest on the second mortgage is usually tax deductible for the home owner.