As many an unhappy homeowner knows, once you start paying private mortgage insurance, it's hard to stop. Much better to avoid this onerous burden in the first place.
Unfortunately, it's hard for most buyers to come up with the 20 percent down payment needed to avoid private mortgage insurance, or PMI as it's known in the industry. The average price of an urban house reached $182,000 at the end of the first quarter this year, according to the Federal Housing Finance Board. A 20 percent down payment on such a house would be a hefty $36,400.With less cash for a down payment, most buyers are required to take on PMI, which protects the lender in case the buyer defaults but offers the buyer no protection at all. Don't confuse this monthly fee with the homeowner's insurance you pay on your own behalf.
Lenders are willing to waive private mortgage insurance if you make a down payment of 20 percent or more because statistics show that people with substantial cash equity in their house are much less likely to default.
But there is another way to avoid PMI - take out a home equity loan at the same time that you get your mortgage.
GMAC Mortgage (800-888-GMAC) is among the lenders promoting this idea. In its trade publication Market Commentary it gives the example of a family buying a $150,000 house with a down payment of either $15,000 or $30,000.
If the family puts down just 10 percent, or $15,000, the monthly mortgage payment with a 7 percent interest rate would be $898.16 and private mortgage insurance would add $58.50 for a total payment of $956.66.
Alternately, the family could make a $30,000 down payment using $15,000 from a home equity loan obtained at the same time as the first mortgage. Monthly payments on the first mortgage at 7 percent would be $798.36. Payments on the home equity loan - a 15-year mortgage with a 10.55 percent interest rate - would be $166.28 a month. The total would be $964.64 - or just $8 more than the other mortgage.
The benefits are that all the interest on both mortgages would be tax deductible while the PMI payments are not. You also accumulate equity faster with the shorter-term second mortgage. And finally, you can pay off the second mortgage early while PMI is hard to drop.
Countrywide (800-570-9888) offers a similar loan combination with a home equity loan at about 10 percent. Source One (800-347-3362) is another option with second mortgage rates between 10.5 and 11 percent.
Countrywide also offers a first mortgage that rolls the PMI into the loan, giving you a somewhat higher interest rate but with all the interest being tax deductible.
You'll note all these second mortgages have pretty high interest rates. But once your house rises in value, you probably will be able to trade for home equity lines of credit at much lower rates. Many lenders now are offering home equity lines at 8.5 percent to 9.5 percent as long as the total debt of first and second mortgages does not exceed 80 percent of the home's value.
If you're a first-time home-buyer, you probably won't have any extra cash at first. But as you get it, double up payments on the home equity loan to get rid of it as fast as possible. That would leave you with a comfortable monthly payment of just $798 on a $150,000 house that already may have risen in value.
You can work a similar deal if you buy a resale house and the seller is willing to carry back a second mortgage to get you up to the 20 percent down payment level. The interest rate and terms in that case are between you and the seller.
GMAC points out that families needing a jumbo mortgage - one that exceeds $227,150 - can use a home equity loan to keep the first mortgage below the jumbo line. So-called conforming mortgages - those below $227,150 - generally carry lower interest rates.
For example, you're buying a $280,000 house and you put down 10 percent, or $28,000. At an interest rate of 7.25 percent, your monthly payment is $1,719.08 plus $109.20 for private mortgage insurance - a total of $1,828.28.
Alternately, you put down 20 percent or $56,000, using a home equity loan of $28,000. By doing this, you both avoid PMI and bring your mortgage down below the jumbo line, so your first mortgage carries an interest rate of 7 percent instead of 7.25 percent.
That leaves you with a monthly payment on the first mortgage of $1,490.28 and a second mortgage payment of $310.83 (on a 15-year loan) for a total of $1,801.66.