If you are looking at financing more than 80% of the value of your your home you will typically have two options, either pay mortgage insurance on the loan or take out a 2nd mortgage for the balance above 80%.
Your credit history, and the estimated appreciation rate for the property will of course play a large part in determining which is the better option for you. Here are a few pros and cons of mortgage insurance that you should consider while making your decision.
Virtually all lenders in the US require PMI on mortgages with down payments less than 20 percent, but some will accept a higher interest rate in lieu of PMI. When a borrower accepts this option, the lender buys PMI for less than the borrower would have to pay. The higher interest rate covers the insurance cost to the lender plus a profit margin.
The sales pitch for the higher rate as a replacement for PMI is that interest is tax deductible whereas PMI premiums are not. The other side of the coin, however, is that you must pay the higher interest for the life of your mortgage, while mortgage insurance will be terminated at some point.
When trying to determine if PMI or a 2nd mortgage is more beneficial, look at all factors. This includes what tax savings you would get from each scenario. To determine the tax savings, figure what tax bracket you are in, multiple this by the amount of interest being paid on each loan. The product is deducted from your payment and the difference is your real world tax savings.
When weighing the options of whether or not a loan with mortgage insurance is right for you, keep in mind that mortgage insurance does not last forever. Even though you may have gotten it with your original loan, that doesn't mean you are stuck with it for life. Whether its via payments to principle, or the value of your home increasing over time, whenever your loan reaches 80% or less of the value of your property, it's time to call your mortgage professional to talk to them about options to eliminate your mortgage insurance.
Once the loan-to-value ratio between your 1st mortgage and your property becomes 80% or less, you are not required to carry PMI. You must contact the PMI insurance company and ask for the procedures to remove the policy. In most cases, you must obtain a full appraisal to confirm the value of the property.
There is also the option of using a non-conforming lender. By using a non-conforming lender you might have a slightly higher rate, but may have a cheaper payment by taking the higher rate with no mortgage insurance. Consult your mortgage professional to find out which option is best for you.
A con of mortgage insurance is that it is not tax deductible. Unlike accepting a higher interest rate and avoiding mortgage insurance and then all of the mortgage interest being tax deductible, mortgage insurance does not provide you with the same tax deductible benefit.
One of the benefits of getting a mortgage loan of more than 80% and purchase Private Mortgage Insurance (PMI) is to avoid the high interest rate of the second mortgage. Typically, homeowners prefer mortgages with PMI over having a second mortgage at times when property values increase dramatically in a short period of time, when homeowners can drop PMI coverage sooner by re-appraising their homes.