Let's face it: Nobody really likes the private mortgage insurance that lenders force home buyers to pay if their down payments are less than 20 percent.
PMI coverage adds $50 to $100 a month to the cost of a typical loan, and can be so troublesome for consumers to get rid of that it took an act of Congress to set the rules straight.
PMI is so unpopular that mortgage experts have been working overtime during the past year to figure out how to cut the insurance costs and hassles out of low-down-payment mortgages. Freddie Mac and Fannie Mae have explored some alternatives and have reduced their PMI coverage requirements, lowering costs slightly for borrowers.
But some major private lenders have now begun experimenting with innovations that broadly fit the description of "look-Ma-no-PMI" mortgages for buyers with modest cash to devote to down payments.
The most notable change, recently rolled out by the country's fifth-largest home mortgage originator, claims to spare borrowers with 10 percent down payments all the headaches of PMI and even cut the mortgage rate a few years down the road. It's called the Advantage 90 loan and is offered by Washington Mutual Bank, which has branches in 29 states and the District.
Its no-PMI and rate-rollback features have made it an instant hit: In just the first 30 days after the program's introduction, Washington Mutual racked up $108 million in no-PMI loans, company officials said. The Seattle-based company believes there is a market for billions of dollars in such mortgages in the months ahead.
But when a big lender says no PMI and low down payments, is it for real? Take a closer look and you begin to discern what's real and what's not.
It's true that borrowers aren't required to pay monthly premiums to a private mortgage insurer, but they must pay a "slightly higher interest rate" for a no-PMI loan, a Washington Mutual spokesman said. For example, if the market rate for loans with down payments of 20 percent is 7 percent, buyers with down payments of 10 percent and no PMI coverage have to pay 7.55 percent to 7.6 percent for their loans. The higher rate approximates the typical premium add-on cost of a conventional PMI policy.
In effect, borrowers are paying Washington Mutual to self- insure its low-down-payment mortgages--that is, to function as a PMI company without being in the insurance business.
What good is that? Aren't you still effectively paying for PMI? You are, but there's an intriguing wrinkle here: When a lender charges you for mortgage insurance but folds the premiums into the interest rate on the note, your insurance becomes tax-deductible through the alchemy of the federal tax code.
The PMI premiums paid by a conventional borrower are insurance costs and are not deductible. But any payments defined by the lender as mortgage interest and secured by a principal residence qualify as tax-deductible home mortgage interest, limited by a $1 million ceiling on the underlying mortgage amount.
What does tax-deductibility save you? Here's an example: On a $200,000 house with a 10 percent down payment, you'd probably save just under $400 a year in federal and state taxes with a no-PMI, $180,000 loan at 7.55 percent, compared with a $180,000 loan at 7 percent with traditional PMI coverage.
The Washington Mutual no-PMI plan has another wrinkle: If inflation pushes the value of your property higher and raises your equity in the house to 25 percent, the lender promises to cut your interest rate by the premium amount you've been paying--say, 0.55 percent.
In a fast-appreciating market where home values are moving up by 6 percent to 8 percent a year, you should be able to cut your mortgage rate within the first five years. Of course, if values are flat, you could be stuck paying the higher rate for years longer. But Washington Mutual says it will cut the rate whenever the loan balance is amortized down to 80 percent of the home value that was used to originate the mortgage. Both cancellation features roughly track provisions in the 1998 federal legislation covering PMI termination.
Other features of the no-PMI concept that could soon be marketed aggressively by lenders:
* On the negative side, the Washington Mutual plan is restricted to adjustable-rate loans, cutting out consumers who want the sleep-at-night security of a fixed-rate loan.
* On the plus side, no escrow accounts are required on the new loan. You get to pay tax and other bills when they come due, not by sending money to your lender every month.
The bottom line is that when you get pitched for no-PMI, low-down-payment plans, you've got to look under the hood. There's a form of mortgage insurance tucked away in there, but it's relatively easy to get rid of, it's tax deductible and it may work for you.