Private mortgage insurance, referred to as PMI on conventional loans and MMI (mutual mortgage insurance) on government loans is an insurance policy that protects lenders in case a borrower defaults on a loan. It doesn’t protect borrowers directly.

On conventional loans, PMI is assessed when the new loan is higher than 80 percent of the value of a home. The higher the loan is above the 80 percent level, the higher the PMI expense. For example a loan that is at 85 percent of the value of a home will have an annual payment of .54 percent of the new loan amount. On a $100,000, this would be $540 per year or $45 per month ($100,000 times .0054 divided by 12.) If the loan was greater than 90 percent of the value of the property, the PMI percent might be 1.2 percent per year. On a $100,000 loan this would be $1,200 per year or $100 per month. All government loans such as FHA loans have mortgage insurance and it is called MMI for “mutual mortgage insurance.”

Since mortgage insurance is expensive, there are several strategies you should consider prior to doing a loan that will require mortgage insurance:

1. Down Payment

The easiest way to avoid mortgage insurance (on conventional loans) is to put at least 20 percent down on a new purchase. Any conventional loan that is less than 80 percent loan-to-value won’t require mortgage insurance. On refinances, keep the loan to value below 80 percent if possible. For example, if your home is worth $200,000 and you need to refinance, you should try and keep the new loan below $160,000 (80% times $200,000.)

2. Consider a Piggy-Back Second Mortgage

A piggy-back second mortgage is a loan that closes along with a first mortgage when you’re purchasing a home. These are often done with the express purpose of avoiding mortgage insurance. They work like this: If you only have a 10 percent down payment, you can get an 80 percent first mortgage and a 10 percent second mortgage (80 + 10 + 10 = 100%). Usually the payments on this type of arrangement are less than a loan that is 90 percent loan to value with PMI added-on.

3. Consider a Self-Insured Loan Option

Most lenders will give you the option of choosing a slightly higher rate than the going rate if you want to forego having mortgage insurance added to your loan. For example, if you only have a down payment of 10 percent, the mortgage rate might be 5.5 percent plus mortgage insurance. The “self insured rate” (with no mortgage insurance added on) might be 5.875 percent. Since all lenders charge a different rate for “self-insured” loans you’ll need to ask your broker or bank for a comparison of a loan with mortgage insurance versus a self insured loan at a higher rate with no mortgage insurance.

4. Avoid Getting an FHA if Possible

FHA insured loans are popular with borrowers because they often times have more lenient qualifying standards than conventional loans. However, all FHA loans require mortgage insurance, even if a large down payment is made. This makes the cost of FHA loans higher than conventional loans. If you have at least a 20-percent down payment, it might be advisable to stick with a conventional loan since it won’t require mortgage insurance.

Tax Considerations

Mortgage insurance is considered a cost of money and is deductible as interest expense on your individual tax return.  A good accountant will help you compare the tax benefits of a loan with mortgage insurance versus a higher interest rate loan with no mortgage insurance.

Eliminating Mortgage Insurance

There are two ways you can eliminate mortgage insurance if it is currently included in your loan. One way is to pay down the principle balance so the principle balance is 80 percent or less than the value of the home. For example, if your current loan balance is $90,000 and your home is worth $100,000, you would need to make a principle payment to the lender in the amount of $10,000 to get the current loan to 80 percent or less ($90,000 less $10,000 equals $80,000 which is 80 percent of the value of the property.)

The other way is to file a formal request with the lender to remove mortgage insurance if the value of the property has gone up enough so that the loan is 78 percent or less than the value of the property. You heard that right: 78 percent. When eliminating mortgage insurance when it is based on property going up in value, lenders use 78 percent, not 80 percent as the loan-to-value threshold. To support the increase in value, you’ll need to contact an appraiser approved by the lender, who will need to do a formal appraisal on the property.