Banks are all about risk and collateral when it comes to making loans. While it’s possible to get a conventional mortgage with less than a 20% down payment, lenders usually require these borrowers to carry private mortgage insurance (PMI). This protects the bank should you default on the loan.
PMI can be expensive. Learn the facts about PMI and you could save more money than just your down payment!
How Much Does PMI Cost?
•This insurance will cost you between 0.25% and 2% of your loan balance per year. It all depends on the amount of your down payment, the terms of the loan, and your FICO credit score.
•There are only six major private mortgage insurance providers in the US. All six have similar rates.
Types of PMI
•Few people realize there is more than just one type of private mortgage insurance (PMI):
•Government Mortgage Insurance. This is for those with government-backed loans, such as FHA or VA loans. Unless you have one of these types of loans, this type of mortgage insurance won’t apply to your situation. However, these government loans are assumable, so it’s helpful to understand the idea of government-provided mortgage insurance.
•Private PMI. This is the type of mortgage insurance that everyone likes to complain about. It provides nothing to the borrower other than the ability to purchase a home with a lower down payment. The insurance only covers the lender if you fail to make your payments.
•How Long Do PMI Payments Last?
•When your equity in your home reaches 20%, you can request to stop making PMI payments.
•When the principal you’ve paid plus your down payment reach 22% of the purchase price, by law, the PMI must be cancelled by your lender, whether you make the request or not. This is true even if your home has lost value in the interim.
•How to Avoid PMI
•One way to avoid PMI is to acquire a second mortgage that will result in only needing a first mortgage at 80% of the home’s value. Of course, then you have a second mortgage, which always has a higher interest rate than a first mortgage.
•The key is appreciation. If your home is likely to increase in value, this can be a great option.
Private mortgage insurance provides a means of securing a home mortgage without the burden of a large down payment. Ensure you understand the details surrounding PMI before applying for a mortgage or assuming a loan that includes mortgage insurance.
Here are steps you can take to cancel mortgage insurance sooner or strengthen your negotiating position:
- Get a new appraisal: Some lenders will consider a new appraisal instead of the original sales price or appraised value when deciding whether you meet the 20% equity threshold. An appraisal generally costs $300 to $500.
- Prepay on your loan, Even $50 a month can mean a dramatic drop in your loan balance over time.
- Remodel: Add a room or a pool to increase your home's market value. Then ask the lender to recalculate your loan-to-value ratio using the new value figure.
Other requirements to cancel PMI
According to the Consumer Financial Protection Bureau, you have to meet certain requirements to remove PMI:
- You must request PMI cancellation in writing.
- You have to be current on your payments and have a good payment history.
- You might have to prove that you don't have any other liens on the home (for example, a home equity loan or home equity line of credit).
- You might have to get an appraisal to demonstrate that your loan balance isn't more than 80 percent of the home's current value.
Getting down to 80% or 78%
To calculate whether your loan balance has fallen to 80% or 78% of original value, divide the current loan balance (the amount you still owe) by the original appraised value (most likely, that's the same as the purchase price).
If at first you don't succeed …
If you can't persuade your lender to drop mortgage insurance, consider refinancing. If your home value has increased enough, the new lender won't require mortgage insurance. Make sure, however, that your refinance costs don't exceed the money you save by eliminating mortgage insurance.
Lenders can impose stricter rules for high-risk borrowers. You may fall into this high-risk category if you have missed mortgage payments, so make sure your payments are up to date before asking your lender to drop mortgage insurance. Lenders may require a higher equity percentage if the property has been converted to rental use.
I hope this helps you understand how PMI or Private Mortgage Insurance works and how eliminating it can significantly reduce your mortgage payment. Contact me if you have any further questions.