Second Mortgage or PMI?

by James & Miel on July 2, 2008 · 0 comments

Like many of you, we get our inspiration from family. Miel and her sister were discussing her sisters lovely new house in Portland. And it came up that, PMI might be involved. For those with a mortgage, you probably know about PMI. PMI stands for Private Mortgage Insurance. PMI is required by some lenders when you have less than a 20% down payment.

Miel’s sisters question was: should you take out a second mortgage or pay for PMI?

Pros and cons of the situation

PMI Pro:
1) PMI has some limited deductiblity. Right, so you can deduct your PMI, but there are several limitations. These are 1) Limited Timing: you have to buy or refinance your home between 2007 and 2010. 2) Income phase outs: your spouse file a joint tax return and have adjusted gross income (AGI) of no more than $100,000 or you file an individual tax return and have AGI of no more than $50,000. 3) Refinancing limits: if you refinance, you can only take the PMI limits on your initial borrowing amount. For example if you bought a house and borrowed $75,000, but refinanced a year later for $90,000 you could only take PMI on the initial $75,000

PMI Con:
1) PMI is an extra expense
This is probably the biggest factor to weigh as a con. Most of the time if you don’t have enough for a full down payment you aren’t likely to want to add more expenses to your monthly budget. Additionally this feels like an expense that is going nowhere, since it is. It can also feel like a penalty for not having enough, thereby possibly giving the feeling of inadequacy when you have to shell out the dough.

Second Mortgage Pro:
1) You don’t have to pay PMI. This means that you can put the funds that would have gone towards PMI will go partially towards your equity, though not much. The major pro is that you’ll have a bit more in your monthly cash flow than you would paying PMI, all things being equal.

Second Mortgage Cons:
2) Interest rates are higher than on a first mortgage. This means that you’ll have a harder time paying it off as you’ll be working against yourself with the interest compounding. For example, we took out our 2006, we split the loan 80 /10, 80% on the first loan, 10% on the second loan. Our first loan had 6.5% and the second had 8.84% – roughly a 2&1/2 percentage point difference.

Given that both PMI and second mortgage have significant drawbacks, we’d advise the following strategies:

1) Do neither! You’re better off having twenty percent down to avoid having to make the choice between PMI and a second mortgage. Saving and investing is old fashioned, but it works. If you have 20% down you avoid both the higher interest rates AND paying PMI.

2) Do the math before you are ready to buy.

3) If you do have to make the choice, then do whatever you can pay down your debt so you aren’t fighting against high interest or insurance payments going down the drain. Paying off your mortgage to below the 20% loan to value ratio will allow you to stop paying PMI. If you pay off your second mortgage you can avoid higher interest rates.

If this post saves any readers from the woes of higher interest or PMI we’ve done our job in the blogsphere.

Readers: We’d love to hear any comments you have on experiences with PMI or second mortgages.

Cheers,

James&Miel

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