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Beware of Lenders Who Say, "I Figured Out a Way That You Don't Have to Pay Mortgage Insurance."

Mortgage insurance is a policy that is paid for by the borrower, with the benefits going to the lender. Is this a fair shake? Of course it is; the buyer didn't have to come up with a full 20 percent down payment; he got to put as little as 5 percent down.

Mortgage insurance premiums can vary depending upon the loan type (fixed or adjustable) and the amount of risk the policy is covering. The greater the down payment, the lower the risk; hence, the lower the premium.

A good way to estimate how much mortgage insurance costs is to multiply the loan amount by 1/2 percent, then divide by 12 to get the monthly premium. Just as with most other insurance policies, the buyer can pay monthly or pay a single premium. Let's look at some sample monthly payments with mortgage insurance (MI) attached.

Sales price $300,000 $300,000

Down payment 10% 5%

Loan amount $270,000 $285,000

30-year fixed rate 6.50% 6.50%

Mortgage insurance 0.50% 0.70%

Loan payment $1,706 $1,801

MI payment $112 $166

Total payment $1,818 $1,967

You'll notice that as the down payment decreases, the mortgage insurance premium increases. One drawback of mortgage insurance is that since it is not mortgage interest, it's not a tax-deductible item for many people. It used to be that mortgage insurance premiums were an expense rather than a tax deduction for everyone; however, in 2007, Congress passed legislation making them a tax deduction for many people. As long as the borrower's adjusted gross income is at or below $100,000 per year, the premiums are tax-deductible just as mortgage interest is.

But there is another way of putting little down and not paying mortgage insurance.

Since mortgage insurance is required for all first-mortgage loans above 80 percent of the value of the home, why not take out two loans? That makes sense, right? If you put 5 percent down, and you have a loan amount secured at 80 percent of the sales price, then you need to either get a mortgage insurance policy to cover the remaining 15 percent or find another mortgage, called a "second" mortgage. This structure is called an 80-15-5.

Another common structure involving a second mortgage has 10 percent down and a 10 percent second mortgage, called an 80-10-10. Let's now look at how subordinate financing works compared with a mortgage loan that carries a mortgage insurance premium.

Sales price $300,000 $300,000

Down payment 10% 5%

Loan amount $240,000 $240,000

Second loan amount $30,000 $45,000

30-year fixed rate 6.50% 6.50%

Second loan rate 8.50% 9.00%

Loan payment 1 $1,516 $1,516

Loan payment 2 $230 $362

Total payment $1,746 $1,878

Notice something? These total monthly payments are remarkably similar to the payments with mortgage insurance. In this example, both loans were amortized over 30 years and were at fixed rates, but there are countless compositions that could include a 15-year fixed rate, an adjustable rate, or other combinations.

Every lender can offer this program, and quite frankly, your loan officer doesn't care if you take this or mortgage insurance; it's no skin off her nose. But sometimes loan officers and mortgage marketing materials make mortgage insurance out to be some kind of plague, and it's not. Do you make more than $100,000 per year in adjusted gross income? Then sure, a first and a second loan might be preferable to mortgage insurance, but you should certainly review all options.

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