Private Mortgage Insurance vs. A Second Mortgage
By Mark Barnes,
il-odm.org Staff Writer
When you take a mortgage that has a loan-to-value of higher than 80 percent, the lender will want you to pay private mortgage insurance or PMI. Your loan-to-value, or LTV, is the amount of the loan, compared to the value of your home. So, if your home is valued at $100,000 and your loan amount is $95,000, then your LTV is 95 percent.
Lenders want to cut their risk, as much as possible. So, they always prefer for a borrower have at least 20 percent of her own money in a property, or that the borrower have at least 20 percent equity in the property. However, lenders do want to loan money and make all of that interest, so they are, in most cases, willing to give mortgages at higher LTVs. Here's where PMI comes in.
When you pay Private Mortgage Insurance, you are, in effect, insuring your mortgage. Or, to put it another way, you are paying a premium, because the lender loaned you nearly as much as your home is worth. So, depending on the loan amount and the LTV, you'll pay anywhere between $40 and $175 extra each month for PMI. If you are planning a new home purchase or to refinance your current mortgage to a better loan program, paying additional money for PMI, may seem less than palatable. There may be a better way.
Sometimes, rather than pay Private Mortgage Insurance, you can take a second mortgage that replaces PMI. There are several factors involved with this decision, so you'll want to use the "What is Better: Take a Second Loan or Pay PMI" calculator here at il-odm.org to help you with your decision.
Assume you are buying a $200,000 home and putting only $20,000 toward a down payment (10 percent). This would give you a new mortgage of a $180,000 with a loan-to-value of over 90 percent. If you take this loan, you might have to pay an additional $150 monthly or more in PMI. What the lender might offer as an alternative to this lofty add-on to your monthly mortgage payment is a second mortgage at $20,000. Essentially, the lender is loaning you money to add to your own twenty grand, in order to bring your interest in the property to 20 percent (20 percent of $200,000 is $40,000).
Now, your new first mortgage will be $160,000. Add your own $20,000 down payment to the second mortgage of $20,000, and you now have a new home with a loan-to-value of 80 percent. This will eliminate PMI.
The key to the deal, from your point of view, is the terms of the second mortgage and the monthly savings. Here's where that PMI calculator, right here at il-odm.org will help. Remember, you're financing less on the first mortgage and probably getting a better interest rate, since the loan is no longer higher than 80% LTV.
The second mortgage will most likely have a shorter term than the first mortgage -- usually 10 to 20 years. The interest rate will be a bit higher, as well, but it should still be good enough that the payment is significantly lower than the $150 or higher you'd pay for PMI. Sometimes, lenders can make the terms of the second mortgage very inviting. You might be able to get an interest-only payment, which would take the combined, or blended, mortgage payment down even more. Assume you get interest-only at 6 percent. This would make your second mortgage payment just $100 monthly. Add this to the savings on the smaller first mortgage and this becomes a much sweeter deal.