If you buy a house or condo, and don’t have a 20% down payment, your bank will usually require you to buy “PMI” - private mortgage insurance. This is because your bank worries that, if you can’t make your mortgage loan payments, they’ll have to foreclose on your property, and sell it off, out from under you. They figure they’ll be able to get at least 80% of the value, at a fire sale, so that’s why 20% is the magic number.

Basically, PMI is an insurance policy protecting the lender from the risk of you reneging on your loan.

The trouble with PMI is, buyers are basically paying for an insurance policy they may never use. And, PMI is not usually tax deductible, so it’s an added burden to borrowers, with no benefits.

Over the past several years, many banks have offered borrowers a way around PMI. Basically, they offer buyers a second mortgage loan, on top of the first 80% loan. The additional loan can be 5%, 10%, 15%, or even 20% of the purchase price, whatever the buyer needs. The borrower usually pays a higher interest rate on this second loan (it may be structured as a “home equity line of credit”, or HELOC), because there is more risk on the part of the bank.

The good thing about the second loan is, it’s usually tax deductible, just like a regular mortgage loan.

PMI is something to learn more about, if you’re thinking of buying, and don’t have enough for a 20% down payment.

More information: Weighing the Cost of Insurance - By Bob Tedeschi, The New York Times

John Keith     September 24, 2006     mortgages and financing

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