When You Can't Afford A Fat Downpayment

You've got your eye on your dream house, but there's a big problem: You can't come up with the downpayment, typically 20%. What should you do?

The traditional and most popular option is to buy private mortgage insurance. With PMI, banks will finance as much as 95% of the purchase price, mainly because the mortgage insurer will jump in if you happen to default on the loan, paying as much as 30% of the value. "With PMI you can increase your purchasing power," says Michelle Chmelar, a broker at Manhattan Mortgage in New York City.

But PMI isn't cheap. While monthly PMI payments are small, ranging from $20 to several hundred dollars, they add up over the life of the loan. In recent years, many banks have begun offering cheaper alternatives, allowing homebuyers to get away with small downpayments, avoid PMI, and reap a substantial tax deduction. By shopping around, you could save many thousands of dollars over the life of your mortgage.

BEG OUT. PMI has its merits. It has been around since 1957 and is popular. The number of new policies issued reached nearly 1.1 million in 1996, triple the annual figure at the start of the decade. One reason is that PMI is readily available for qualified homebuyers. And if you start missing monthly payments because of a job loss or a major medical expense, the insurer will generally serve as your advocate with the lender, helping restructure your loan terms.

Furthermore, you're not stuck with PMI forever. Since PMI coverage usually isn't required once a homeowner's equity in the property grows to 20% or more, you can ask your bank to let you beg out. Still, that's not always easy, says James Kumas, production manager of Mizner Mortgage. You need to arrange for a property appraisal to determine the value of the house and your equity in it. Mortgage insurers and banks aren't obliged by law to notify homeowners when they've reached 20%, although pending legislation could change that. For now, it's up to you to get it done.

PMI's principal drawback, though, is that the payments are not tax-deductible. And because of the difficulties in getting out of your PMI policy, you may wind up paying for the insurance for a far longer period than you need to.

Many leading banks are now offering a financial arrangement called an 80/10/10 second trust. Under Chase Manhattan's plan, known as EasyClose, consumers who qualify put down 10% and borrow the rest through a pair of mortgages. The first mortgage covers 80% of the purchase price. It extends for a relatively long term--15 or 30 years--and carries a low interest rate. The second mortgage finances the remaining 10% at a higher interest rate and shorter term: 5 to 10 years. With an 80/10/10, you avoid monthly PMI payments, and the interest on both mortgage payments is often tax-deductible. Depending upon how the loans are structured, you may pay less than under a more traditional arrangement.

BYPASS. Take a $450,000, 30-year, 8.25% mortgage where a buyer can put only 10% down. If the buyer used PMI, his total payment would be $3,204.63 monthly--$3,042.63 for the mortgage payments and $162 for PMI. If he used EasyClose, the monthly payment would be $3,138.82--$2,704.56 for the mortgage and $434.26 for the second mortgage. The two total payments are roughly the same. But because interest on the EasyClose payments would be tax-deductible, the buyer in a 40% tax bracket would save about $300 in taxes in the first year.

Several other loan products bypass PMI. Chase and other banks will let a buyer borrow more than 80% on an uninsured home loan, but they charge a higher interest rate (usually from 3/8 to 3/4 of a percentage point) to compensate for the higher risk. In another variation, banks charge a higher interest rate and actually purchase PMI themselves. "Competition has forced us to be innovative," says Robert Donovan, mortgage specialist at Chase Manhattan.

With the competition heating up between the private mortgage insurers and banks to help you buy your dream house, you may be able to get a better deal than you think.