Mortgage Insurance, also know as Private Mortgage Insurance (PMI) or Mortgage Protection Insurance, is insurance paid by the borrower to protect the lender against their failure to repay the home loan. Lenders require PMI on all home loans that have less than a 20% downpayment, that is a mortgage of more than 80% of the home’s appraised value or Loan-to-Value (LTV).

Piggy-back Loans to Avoid PMI

PMI can be a very expensive additional cost to buying a home, particularly since PMI protects only the lender and provides no benefit to you, the buyer. This is why in recent years many mortgage lenders have created innovative ways to avoid PMI.

The most common way to avoid PMI is by adding a piggy-back loan (second mortgage) to the first mortgage. This second loan, often a home equity loan or home equity line of credit is used to finance the portion of the 20% downpayment the borrower is unable to pay.

The most popular programs are 80/10/10 or 80/15/5; meaning the borrower’s first mortgage is 80% of the home’s value, the second mortgage is 10% or 15% of the home’s value, and the borrower is only left to put down 10% or 5% of the home’s value.

Typically, the second mortgage is held by a second lender so the first lender is still protected with a 20% equity cushion and the second lender is comfortable taking this additional risk of default by charging the borrower a much higher interest rate for the second loan.

Benefits of Private Mortgage Insurance (PMI)

The benefits of PMI to borrower is really very little. It offers you no protection and you are paying to insure that you don’t default on your mortgage payments, all the while making that payment more with PMI.

If there is an advantage it is that you can buy a home with less of a downpayment and finance the cost of the additional required 20% downpayment and the cost of PMI.

The Homeowner’s Protection Act (HPA) of 1998

One of the big injustices of PMI in the past was the even after a borrower would pay their loan down to less than 80% of their loan-to-value mortgage insurers would often continue to collect premiums, often until the loan was paid off. In 1998 this practice was corrected by legislation with the passing of the Homeowner’s Protection Act.

This new law required that mortgage insurer stop collecting premiums when the mortgage was paid down to 78% of the original value of the home or half of the amortization period was reached.

Is PMI Tax Deductible?

In 2007 Congress, under the Tax Relief and Health Care Act of 2006, made another borrower friendly adjustment to mortgage insurance. Now a portion and in some cases (i.e., households with income below $110,000) all of PMI premiums are tax deductible. In some cases this could actually make PMI cheaper than using a piggy-back loan to assist in making the 20% downpayment.

In most situations it is to the borrowers advantage to put 20% down on their purchase of a new home. However, if you just can’t wait and you’re willing to pay a little bit more in interest or PMI premiums there may be options to get a mortgage with significantly less than 20% down.