Many homeowners struggle with coming up with the traditional 20% down payment when it comes to purchasing a home. Unless you are able to save aggressively or there is significant enough equity in a home you are selling to help cover the expense, a lower down payment is common among American homeowners.
However, with that smaller initial investment comes a higher cost, by way of private mortgage insurance. Understanding private mortgage insurance, or PMI, along with how to cancel it when you are eligible, can help you keep home-ownership affordable for the long haul. Here’s what you need to know.
What is Private Mortgage Insurance
Private mortgage insurance, most often referred to as PMI, is a protection put in place on certain home loans. When a home-buyer is not able or is unwilling to put a down payment of at least 20% toward a new home purchase, a lender may require PMI to help protect its investment. Because a lower down payment equates to a higher risk loan, PMI is meant to offset this risk by paying the lender in the event the borrower defaults on the loan.
Private mortgage insurance is not homeowner’s insurance – it provides no benefit to the homeowner, but instead, represents an added cost to the mortgage for the benefit of the lender. The cost of PMI ranges from 0.5% to 1% for most loans that require it, and it is in place until the borrower reaches a point in their mortgage repayment when it may be canceled. Although PMI provides a solution for home buyers who do not have the 20% down payment available, it is worth coming up with a plan to work toward its cancellation to help save money each month.
Options for Canceling
There are a handful of ways PMI may be canceled on your loan, each with its unique benefits and downsides. Here’s what you should know about the options available to you as a homeowner with PMI.
Wait for PMI to Automatically Cancel
Unlike mortgage insurance required by home loan lenders offering FHA loans, private mortgage insurance is automatically canceled once the mortgage reaches a specific point in repayment. When a loan with PMI is issued, a cancellation schedule should be provided to let the homeowner know when this automatic cancellation is set to occur. However, it is essential to keep track to ensure it falls off the loan – and your monthly payment – when anticipated.
Depending on the down payment, PMI cancellation may be scheduled for a few to several years from the start of the loan, typically when the home equity in the property is predicted to reach 78%. To calculate your home’s equity, take the balance remaining on the mortgage and divide it by the market value, or what you could sell it for. Let’s say you ow $150,000 on your loan, and it could sell for $200,000. Your home equity is at 75%, and PMI should no longer be part of your monthly mortgage payment.
Ask for an Early Cancellation
If you don’t want to wait for it to be automatically removed, or you’re concerned your lender won’t follow through, you can ask for an early cancellation instead. When your mortgage balance hits the 80% mark of the original value of the home, you may request the PMI be canceled by your lender. However, there are a few rules when it comes to this option.
First, you have to have a strong repayment history on your loan to qualify for this option. Lenders aren’t too keen on allowing you to remove it early if you haven’t kept up with your mortgage payments. Also, you can’t have another lien on the property. This means no second mortgage loans or lines of credit in place. Additionally, some lenders may require an updated appraisal to verify the home’s current value. Be sure to check for this and other requirements before submitting a request for cancellation of your PMI.
Get an Appraisal
When you believe the value of your home has increased significantly from the time you purchased, early removal may be a viable option. However, you’ll need to get an appraiser to evaluate your home’s actual market value, not just come up with a number out of the blue. It is crucial, however, to ask your lender if they have specific appraisers they work with, so you don’t waste a few hundred dollars for an appraisal they won’t accept in the end.
Refinance Your Mortgage
Another option for cancelling private mortgage insurance is refinancing your home. If your credit has improved since taking out the initial mortgage, or if the value of your home has increased, a refinance may be a smart move. Refinancing involves taking out a new loan altogether, hopefully with better terms such as a lower interest rate or lower monthly payment. Some lenders may offer no PMI on a refinanced mortgage, but typically only when the loan-to-value is at the magic 80% threshold.
Before refinancing, though, be sure to do some serious number crunching. Getting a new mortgage comes with expenses, including closing costs that can range from a few to several percent of the loan amount. Although these costs are often rolled back into a refinanced loan, so not an out-of-pocket expense, they will ultimately add to the total amount you repay over time for a new loan.
A Final Note About PMI
Private mortgage insurance seems like a headache to deal with and to pay each month, but it creates more home-ownership opportunities for those who cannot afford a 20% down payment. Homeowners with PMI can use the mentioned strategies to get rid PMI over time, but the process isn’t always as straightforward as one might think. If a lender is giving you the run around when you know you are eligible to cancel, know your rights as a consumer. The Consumer Financial Protection Bureau allows you file a complaint if you’re having an issue with your lender and PMI cancellation. That can be done quickly online.
