If your down payment on a home is less than 20 percent of the appraised value
or sale price, you must obtain private mortgage insurance, known as PMI, with
your lender. This will enable you to obtain a mortgage with a lower down payment
because your lender is now protected against any default on the loan.

PMI charges vary depending on the size of the down payment and the loan, but
they typically amount to about one-half of one percent of the loan, according to
the Mortgage Bankers Association of America. Mortgage insurance premiums are not
tax deductible.

Example

Let's say you put down 10 percent or $10,000 on a $100,000 house. The lender
multiplies the 90 percent loan, or $90,000, by .005 percent. The result is an
annual PMI of $450, which is divided into monthly payments of $37.50.

Most homebuyers need PMI because 20 percent of the sale price on a home is a
lot of money; for instance, that's $20,000 on a $100,000 home. Homebuyers must
maintain the PMI premiums until they cross that one-fifth-of-principal
threshold, a process that can take years in longer-term mortgages.

Tip

Keep track of your payments on the principal of the mortgage. When you reach
80 percent equity, notify the lender that it is time to discontinue the PMI
premiums. A new law that takes effect in the summer of 1999 will require lenders
to tell the buyer at closing how many years and months it will take for them to
pay 20 percent of the principal to cancel PMI.

Note: The law does allow lenders to continue requiring PMI all the way down
to 50 percent equity for so-called high-risk borrowers. Traditionally, those
loans that are considered riskier include reduced documentation loans, in which
customers provide less proof of income and other information during the approval
process. Loans for people with spotty credit histories and higher debt-to-income
ratios also fall into this category. Additionally, some FHA loans require
payment of PMI throughout the entire life of the loan.

Ways to avoid PMI

In today's market, there are some new ways to avoid mortgage insurance even
when you don't have the standard 20 percent down payment.

Pay more interest: Some lenders will waive the mortgage insurance requirement
if the buyer accepts a higher interest rate on the mortgage loan. The rate
increases generally range from .75 percent to 1 percent, depending on the down
payment. The advantage is that mortgage interest is tax deductible.

Using an "80-10-10" loan: This program involves two loans and a 10 percent
down payment. The 90 percent loan is financed with a first mortgage equal to 80
percent of the sale price, and a second mortgage for the remaining 10 percent of
the sale price. The second mortgage has a higher interest rate but since it
applies to only 10 percent of the total loan, the monthly payments on the two
mortgages are still lower than paying one mortgage with mortgage insurance.
Plus, again, there is the advantage of mortgage interest being tax deductible.

Example: If we compare the purchase of a $100,000 home under the "80-10-10"
plan with a standard fixed mortgage including PMI, we find that the former is
$17.45 cheaper each month.

Here's how it works. Under the "80-10-10" plan, the 10 percent down payment
on a $100,000 house is $10,000. The first mortgage is $80,000 at 7.50 percent,
which comes to a monthly payment of $559. The second mortgage for $10,000 has a
9.50 percent interest rate, making a monthly payment of $84. Total monthly
payments of the two loans: $643.

With a $10,000 down payment, one mortgage of $90,000 at 7.50 percent has a
monthly payment of $629, plus PMI of $31.45, making a total payment of $660.45.