What is Mortgage insurance?
Why am I paying mortgage insurance?  If you originally mortgaged more than 80% of the purchase price of your home, you are either paying mortgage insurance (PMI), or you used a combination of two mortgages.

What is mortgage insurance?  It is an insurance policy to protect your lender in the event you default on your loan and force the lender to foreclose.  Through foreclosure, the lender will seize your property and sell it at auction in an attempt to recoup their money.  Foreclosure is an expensive legal process, and by the time the lender can actually sell your home at auction, there are legal fees, past-due fees, and accrued interest added onto the principal balance of your loan.  Based on national sales, the average amount the bank will receive is 80% of the value.  If the balance owed is greater than the amount the house is sold for, the lender takes a loss.  This loss can be quite substantial and, when such losses are compounded nationwide, will drive up the cost of mortgage transaction for lenders.

In order to off-set such costs, lenders require mortgage insurance on any mortgage over 80% of the home value.  Mortgage Insurance reimburses the lender for their losses, should it become necessary.  Since the risk comes from the homeowner in the form of payment default, the cost of the insurance is passed along to them, as well.

The cost of mortgage insurance is determined by your Loan to Value – how much you owe as a percentage of your home value.  The higher this percentage, the higher the lender’s risk that they will experience a loss in the event of a foreclosure.  As with any insurance, the higher the risk, the higher the premium.  The loss risk and insurance premiums are pooled nationwide by the mortgage insurance companies.  So, the money you pay each month with your timely payments is used to pay for the losses caused by the delinquency of others.  Furthermore, this portion of your mortgage payment is not deductible on your taxes.

There are ways to avoid paying Mortgage Insurance.  The most obvious way is to have 20% equity in your home.  The other way is to take out a first and second mortgage, where the first mortgage is equal to or less than 80% of your home value.  Unlike Mortgage Insurance, the interest you pay on your first and second mortgages is tax deductible.  The interest rate on a second mortgage is usually higher because of the increased risk to the lender, but the lower overall cost of a two-piece mortgage makes them attractive.

If you currently have two mortgages or you are paying PMI, it is a good idea to consider refinancing.  Many homes have appreciated to the point that they have at least 20% equity.  By consolidating a first and a second mortgage and/or by getting rid of Mortgage Insurance, you may find significant monthly savings. 

12/19/07
President Bush is expected to sign legislation that will continue to allow low and moderate income homeowners to deduct their private mortgage insurance premiums from their taxes through 2010.  All homebuyers with adjusted gross incomes below $100,000 will be able to deduct 100% of their mortgage insurance costs. 

This is great news for home buyers who plan to put less than 20% down when they buy.  It makes the 1 loan with PMI option a more viable one… in the not so distant past, the majority of financing was being broken into 2 loans.  For instance, an 80% first, and then a higher rate 10 or 15% second mortgage BUT there was no mortgage insurance.  Home buyers should now compare this option with the 1 loan option and see what makes the most sense.