Private Mortgage Insurance (PMI)
Private Mortgage Insurance (PMI) is insurance designed to protect the lender in case the borrower can not repay the loan. The insurance premiums are paid by the borrower buy are payable to the lender. PMI can be paid up front but is often capitalized into the loan. It is typically only taken out when the borrowers down payment is less than 20% of the value of the home (LTV of 80% or less). Once PMI is taken out it can be difficult to cancel as it may require a reappraisal of the property and approval of the lender.
PMI can be expensive in two ways. First, PMI premiums typically cost 1-2% of the loan amount annually. In San Francisco this can mean tens of thousands of dollars. Second, PMI payments , unlike interest payments, are not tax deductible. As such, borrowers tend to try and avoid paying PMI if at all possible. One way to do this is to utilize a second mortgage, or “piggyback loan”. These loans are structured so that the borrower can meet the 80% LTV requirement by taking out a second loan. The two most common types of second mortgage loans are 80/10/10 and 80/15/5. In both, the borrower can avoid PMI and receive the interest tax deduction.