- The Washington Times - Friday, April 19, 2002

Private mortgage insurance (PMI) is possibly the most universally despised expense of homeownership. To hear some consumers, they would offer to walk on hot coals if it would get them out of paying PMI, charged by lenders to borrowers who initially make a down payment of less than 20 percent.

Borrowers pay the premiums, but the insurance protection only benefits the lenders. Unlike many other homeowner payments, PMI is not tax-deductible.

Lenders point out, correctly, that PMI has enabled many middle-income familes to buy homes that could not afford to pay 20 percent down. Still, those nagging monthly payments have spawned some creative financing tools 80-10-10 and 80-15-5 loans, for instance and they help keep home appraisers busy when refinancing rates dip and property values rise.

PMI can be avoided from the outset simply by paying more than 20 percent down when obtaining a mortgage. Also, later, borrowers with more than 20 percent equity in their homes can also request that their lender stop charging PMI. It can happen sooner than you might think in today's real estate market.

"Lots of people have seen appreciation on their homes in recent years," says Michael Bikowski, branch manager for the Fair Oaks office of North American Mortgage Co., a division of Washington Mutual. "The simplest thing to do if you think your home has risen enough in value is to refinance and see if you have enough equity to eliminate PMI with a conventional loan program.

"However, if your interest rate is below 6½ percent, it makes more sense to call your mortgage lender and find out if your appreciation has risen enough for them to drop PMI," Mr. Bikowski says.

Borrowers with less than 20 percent in cash for a down payment on a new loan, or less than 20 percent equity in their home for a refinance, need another strategy. There is a less cash-intensive method to eliminate PMI.

"A popular strategy in recent years to avoid PMI on a low-down-payment loan has been what's known as an 80-10-10 loan," says Jim Capps, regional senior vice president of the mid-Atlantic division of Market Street Mortgage in Annandale. "This means that the main mortgage covers 80 percent of the value of the home, with a second trust of 10 percent and a 10 percent down payment. Another option is an 80-15-5 loan, which accomplishes the same purpose of avoiding PMI while requiring less cash up front."

A second trust loan, according to Mr. Bikowski, "looks and feels like a first trust. The payment can be calculated as a straight fixed-rate loan over 15 or 30 years. The 15-year loans are running in the low 8 percent interest rate right now, with the 30-year loans running in the high 7 percent interest rate.

"There are lots of different gradations of interest rates based on the borrowers' credit rating and the loan-to-value," he says. "Many loans are calculated with a balloon feature, but that balloon payment shouldn't be too scary for most people because it represents a small piece of the whole mortgage, and, besides, the average total loan prepay in this area takes place at seven years."

Refinancing with this type of loan program also works to eliminate PMI for borrowers who have equity available in their home but have not yet reached an 80 percent loan-to-value ratio.

"If someone originally had a 95 percent loan with PMI and the value of their home has gone up to 90 percent loan-to-value, then this owner could do an 80-10-10 loan, with that last 10 percent coming from the equity in the home," Mr. Capps says. "Refinancing with this method can even be done by someone with only 5 percent equity in their home, with an 80-15-5 loan."

Mr. Capps suggests that even with interest rates rising slightly in recent months, refinancing to get rid of PMI is a good strategy for lowering the monthly payment even if the drop in interest rate is not that significant.

Borrowers interested in refinancing to eliminate their PMI need to be aware of several factors that could influence their decision. First, second trust loans require good credit. Second, second trust loan rates are slightly higher than first trust loans. Third, a good estimate of the costs of refinancing needs to be made.

"There are plenty of deals out there to eliminate PMI, but people need to know that they need pretty good credit to get a second trust," says Bob Gill, senior loan officer with First Horizon Home Loan in Fairfax. "Lenders are aware that if a home should go into foreclosure, the first loan will be paid off in full and the second loan will be paid only if there is enough money made from the sale of the home to cover that loan. So the second trust loans are made at a higher risk to the lender."

Because of this risk, second trust interest rates tend to be about ½ to 3/4 of a point higher than interest rates on first trust loans, Mr. Gill says.

"The interest rate on a 15 percent trust [an 80-15-5] is also a little bit higher than the rate for a 10 percent trust [an 80-10-10]," Mr. Gill says. "The theory behind this, and the reason lenders traditionally charge PMI on low down payment loans, is that studies have shown that 5 percent down payment loans default twice as frequently as 10 percent down payment loans."

Choosing to refinance to eliminate PMI makes sense in most cases because the PMI payment is replaced with a second trust payment that is tax-deductible and the total monthly payment is usually lower, too. Closing costs, however, are associated with refinancing that must be estimated and evaluated.

"Refinancing is slightly more expensive in Virginia than in Maryland," Mr. Bikowski says. "Virginia charges a re-recordation fee, which Maryland doesn't do. Typically, when a borrower refinances, they must re-establish an escrow account, either by writing a check or including the amount in the loan.

"In Maryland, real estate taxes are paid only once a year, so the amount can be pretty substantial," he says. "In Virginia, taxes are paid twice a year, so usually borrowers will need a little less money to place in escrow. After the refinance, the homeowners will get their escrow money back from their original mortgage company."

Determining whether a refinance makes financial sense relies on a number of factors.

"The combination of increased home values and low interest rates has helped make refinancing valuable," Mr. Gill says. "Then it's just a matter of deciding how long you're staying in a property and how long it will take to recoup your costs. A very simple example is this: If a borrower has $1,000 in closing costs and has a lower monthly payment of $100, it will take 10 months to recover the costs of the loan. After that, that $100 will be pure savings every month. A full disclosure and a good estimate of the settlement costs helps people make the right decision about refinancing."

Consumers with FHA and VA mortgage loans are in a slightly different position from those with conventional loans.

"FHA and VA loans are designed as low down payment loans which are government-backed," Mr. Bikowski says. "VA loans, which require no down payment, don't charge mortgage insurance, but they do have loan guarantee fees up front. FHA loans require 3 percent down and require mortgage insurance for the life of the loan. The only way to drop mortgage insurance on an FHA loan, no matter what the loan-to-value on the home, is to refinance with a conventional loan."

According to Mr. Gill, "Consumers with FHA loans also have to pay 13/4 percent as an up-front Mortgage Insurance Premium (MIP), along with a monthly MIP payment. If FHA borrowers choose to refinance with a conventional loan, they eliminate the MIP and also get a refund of part of that original lump sum premium as long as the refinance is within seven years of the origination of the loan.

"The amount of the refund varies, of course, but in some cases borrowers can get up to 90 percent of their payment back," he says. "So many people, especially first-time buyers, bought their homes with an FHA loan a few years ago because they could make a low down payment and the credit restrictions were a little easier.

"Now their home value has gone up and their credit scores are better if they've been paying their loan on time, so they should refinance. Not only could they have a lower monthly payment and no more mortgage insurance payments, but they could also get a refund from FHA," he says.

Refinancing to eliminate PMI makes sense for most homeowners, whether they have 10 percent equity or 20 percent equity in their home. In either situation, consumers can find a lender who will arrange a conventional loan program, or an 80-10-10 or an 80-15-5, or even another combination that might work.

Determining how long the property will be owned is a crucial element in the decision to refinance, but it's worth a few minutes of research with a lender to decide if the refinancing option works for you.

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