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Should you refi, even if it means paying PMI?

Liz Weston
Runner stretching outside city | Sam Edwards/Getty Images

Sam Edwards/Getty Images

With mortgage rates so incredibly low, would you like to figure out whether a mortgage refinance makes sense? The task involves some math. If you might have to pay private mortgage insurance, or PMI, the math gets a bit trickier.

What adds urgency to the equation is the possibility of higher mortgage rates in the future. Should you lock in low rates now, even if it means paying PMI? Or should you wait to refinance until you have more equity and can avoid PMI -- and risk getting stuck with higher interest rates?

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PMI payments might be less

To decide, you first need to know how much you'll pay for PMI, which protects the lender in case you default. Hint: It's probably not what you're paying now. If your credit scores have improved or your equity has increased -- either because you've paid down your principal or home values have risen, or both -- PMI might cost you substantially less than you're paying now.

"So if you started out with 5% down, your PMI (with the current loan) would be more," says Ilyce Glink, author of "100 Questions Every First-Time Home Buyer Should Ask." "If you can refinance 3 years later and because your home has gone up in value you now have 17% equity, PMI payments will be much less."

PMI is typically required when you don't have a 20% down payment or 20% equity in the property. Annual PMI premiums usually range from 0.3% to 1.5% of the amount borrowed. Other factors that influence what you pay, besides loan-to-value and credit scores, are loan size, the loan term and "coverage," or how much of a loss the insurer will cover.

How coverage varies

You may need to know the PMI coverage percentage if you're using one of the many available PMI calculators to estimate how much your monthly payment is likely to be. With 10% equity or less, PMI typically covers a loss to the lender of up to 30% of the loan balance. With equity closer to 20%, it's 12%.

Another way to find out the cost is to simply ask a lender, Glink says.

Options for those with enough equity

If you have at least 10% equity in your home, you have other options to consider, such as:

  • A 2nd mortgage, either a home equity loan or line of credit, to avoid PMI.
  • Lender-paid mortgage insurance, in which you pay a slightly higher interest rate in exchange for your lender paying the insurance in an upfront lump sum.

The interest on both alternatives is tax-deductible, which isn't the case with PMI. But unlike regular mortgage insurance, lender-paid mortgage insurance doesn't "fall off" or end when you have sufficient equity. You pay the higher interest rate until you sell or refinance.

So ... should you refi?

Once you know the costs of your various options, you still have to answer the question: Should you pull the trigger and refinance?

No one really knows when interest rates will rise, or how fast, says mortgage expert Dick Lepre, who writes the RateWatch weekly newsletter. So the question to ask is whether you can save money now.

Lepre suggests you first calculate whether you can save money with a no-cost refinance -- one that doesn't require you to pay anything out of pocket. If you can't save much, then you probably shouldn't refinance.

If you could lower your payment, though, then you proceed to the next step, which is seeing how much you can save by paying closing costs yourself.

"If you get your money back in less than 2 years, then it's a good deal," Lepre says. "If it takes more than 5 years, it's a bad deal. Anything in between is a coin toss."

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