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by Barry Tadmore

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Private Mortgage Insurance, more commonly referred to as PMI, is an insurance that the borrowers pay for in order to protect the lender. This payment is usually included in your monthly mortgage payment. Not all borrowers must pay PMI, however. Only those borrowers who don't have a 20% down payment are required to make that extra payment each month.

As today's home prices continue to raise, it's becoming all too uncommon for someone to have a 20% down payment. I bought my first home for $240,000 three years ago. I was less than one year out of college, so how was I going to come up with $48,000 for a 20% down payment? There was, of course, no way possible. I could only afford a 3% down payment. So I had two choices for financing:

1. One mortgage, 97% Loan-to-Value (LTV), and paying PMI. Since I was financing a loan at more than 80% the value, the bank can take out an insurance policy to cover the rest of the 20%. Unfortunately, the bank doesn't pay for that insurance policy. They pass that on to the lender in the form of PMI payments added on to the monthly mortgage payment. In my case, it was $160 additional each month.

2. I could do a "piggy-back loan" where I took out a first and a second mortgage. The first mortgage would have been for 80% of the home's value while the second mortgage was for the remaining 17%. This eliminates the need for mortgage insurance because the lender in turn charges a higher interest rate for the second mortgage, as it's usually a riskier loan. The benefits of the second mortgage is that the interest you pay on the second mortgage is tax-deductible, whereas until this year (2007), PMI premiums weren't tax deductible.

When I had a choice between the two financing packages, it was obvious to me that PMI was the best bet. I figured that in 3-4 years I would be able to drop my PMI and cut $160 off my mortgage payment. But if I took a second mortgage, it would take 15 years to pay that off. Here is the monthly payment difference I was looking at:

First mortgage with PMI:
$1,490 for principal, interest, taxes, insurance. $160 for PMI. Total payment of $1,650.

Second mortgage:
80% first mortgage: $1,257
17% second mortgage: $394
Total payment: $1,651

Throw in the tax advantage of having a 15-year mortgage instead of PMI and I should've gone with the piggy back loans, right? I disagree, because with that option I was locked into paying that total of $1,651 for 15 years. I would rather cut my total down to $1,490 within three years or so of owning my home. And guess what? I just had an appraisal done on my home and I currently only owe 77%! My next month's payments just got reduced by $160!

So there is mortgage insurance defined with a real-life example. I hope it helps. Just understand that choosing PMI was my decision at the time and that you should always do what's right for your situation. But keep in mind that in 2007 they passed a bill that made it legal to deduct your PMI insurance premiums. To me, it seems like a no-brainer to add PMI instead of piggy-back loans!

Learn more about this author, Barry Tadmore.

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