Private Mortgage Insurance (PMI)

Private Mortgage Insurance (PMI). . . What It Is, and How to Avoid It

Private mortgage insurance (also known as 'PMI' or 'MI', for short) is required on certain loans to protect the lender against financial loss in the event of borrower default. As a general rule, if your down payment is less than 20% of a home's purchase price, a lender will require you to pay PMI. That is because loans with lower down payments are considered to be riskier, as a whole, than loans with higher down payments. Depending on the loan amount involved and your credit profile, PMI can cost as much as 1.25% of the original loan amount per year. To put that in practical terms, on a $250,000 loan, PMI could cost as much as an additional $260.42 per month! (PMI payments are also generally not tax deductible).

Fortunately, it is often possible to structure your financing so as to avoid having to pay PMI in the first place. The most popular way to do this is to split your financing into two distinct mortgages - a 1st mortgage (also known in some jurisdictions as a '1st trust') and a 2nd mortgage (or '2nd trust'). So long as the 1st mortgage does not exceed 80% of the home's purchase price, most mortgage programs will not require you to pay PMI. Although the 2nd mortgage will frequently have a variable interest rate, or if the rate is fixed, a higher rate than that on the 1st mortgage, the benefits of avoiding PMI usually greatly outweigh any potential drawbacks to structuring your financing in this way.