Private mortgage insurance (PMI) is a type of insurance policy that protects lenders from the risk that the buyer will default and push the mortgage into foreclosure. It also allows buyers who cannot – or choose not to – make a significant down payment to obtain mortgage financing at affordable rates. If you purchase a home and put down less than 20%, your lender will probably minimize its risk by requiring you to buy insurance from a PMI company before signing the loan.
PMI benefits the lender (the sole beneficiary of PMI), but it can add a sizable chunk to your monthly house payment: It typically costs about 0.5 to 1% of the loan amount annually. PMI on a $200,000 loan, for example, could cost up to $2,000 per year, or $166.67 each month, assuming a 1% PMI rate.
Don’t confuse PMI with mortgage life insurance, which goes to you (or your beneficiaries) to pay off your mortgage if you die or become disabled. See How can I avoid paying private mortgage insurance (PMI)? for more information on PMI.
Because premiums are expensive (and a PMI policy benefits the lender, not you), it's important to understand when – and how – you can get rid of your PMI.
Homeowners Protection Act
The Homeowners Protection Act of 1998 (the "PMI Cancelation Act") became effective July 29, 1999. The Act addressed difficulties that homeowners were experiencing in canceling PMI coverage after they had reached the required equity level, and it established uniform procedures for canceling and terminating PMI policies. The Act applies primarily to residential mortgages originated after July 29, 1999 (if your loan was issued before that date, you will have to contact your lender for further information).
The Act outlines three situations where borrower-paid PMI can be eliminated: automatic termination, borrower-requested cancelation and final termination when the loan reaches its midpoint.
In accordance with the Homeowners Protection Act, your lender must terminate PMI on the date your loan balance is scheduled to reach 78% of the original value of your home (in other words, when your equity reaches 22%), provided you are current on your mortgage payments. If you are not current on your payments on the date that your mortgage is scheduled to reach the 78% threshold, the lender must automatically terminate PMI on the first day of the first month following the date that you become current. Once PMI has been terminated, the lender can't require further PMI payments more than 30 days after the termination date or – if you are behind on payments – the date after termination that you become current on your payments, whichever is sooner.
It's important to recognize that the 78% threshold is based on the date that the loan is scheduled to reach 78%, according to your amortization schedule, not on your actual payments. That means that if you made extra payments and reached the 78% threshold ahead of schedule, your lender does not have to terminate PMI until the originally scheduled date, which could leave you making months – or even years – of unnecessary PMI payments. To avoid making excessive payments, you can request cancelation of PMI coverage (see next section). Also note that FHA mortgage requirements differ from conventional loans, and depend on when your loan originated and how much money you put down. Check with your lender to find out how and when you can drop the mortgage insurance premium (PMI).
Under the law, borrowers with a good payment history can request that PMI be canceled when their equity in the property reaches 20% of the purchase price or the appraised value. You have a "good payment history" if you have:
- not made a payment that was 60 days or more past due within the first 12 months of the last two years prior to the cancelation date (or the date that you request the cancelation, whichever is later); or
- not made a payment that was 30 days or more past due within the 12 months prior to the cancelation date (or the date that you request the cancelation, whichever is later).
By law, lenders are required to inform you of your right to cancel PMI. Not surprisingly, before the law was enacted, lenders could (and often did) continue to require monthly PMI payments long after borrowers had built substantial equity in their homes and the lender was no longer at risk of loss from the borrower's default. That is now illegal.
To request cancelation, you must:
- Submit a written cancelation request;
- Have a good payment history;
- Be current on your mortgage payments;
- Satisfy lender requirements for evidence that the property's value has not fallen below the original value (such as an appraisal); and
- Provide certification that your equity in the property is not subject to a subordinate lien (such as a second mortgage).
Once PMI has been canceled, the lender can't require further PMI payments more than 30 days after the date your written request was received, or the date that you satisfied the evidence and certification requirements, whichever is later.
Paying down your mortgage isn’t the only way to build the equity that permits you to request a cancelation. Making improvements that add enough value to your home can also bring you to the required minimum. If you are doing a big renovation – a significant kitchen remodeling, for example – review the numbers to see if you now qualify for a written PMI cancelation request.
If you have not yet reached the 78% threshold, you may still be able to eliminate PMI payments. Under the law, your lender must terminate PMI by the first day of the month following the date that your loan reaches the midpoint of its amortization schedule. That “midpoint” is halfway through the period between your loan-origination date and the date when the mortgage is scheduled to be amortized. A 30-year loan, for example, would reach the midpoint after 15 years.
Again, you must be current on your payments for final termination to take effect. If you aren’t, PMI will be terminated when you do become current. Your lender can't require payments for more than 30 days after PMI is terminated.
One More Option: Refinancing
Homeowners may have another option to get rid of PMI: refinancing. If you think your home's value has appreciated, a new loan may account for less than 80% of the home's value, meaning you will not have to pay PMI. While this can help homeowners, it's important to do some number crunching beforehand to make sure that refinancing makes financial sense. In general, if you can refinance at a favorable, lower-interest rate and get rid of PMI at the same time, it might be a good move.
The Bottom Line
If you can’t put down 20% of the price when you buy a home, your lender will require that you buy private mortgage insurance. PMI protects the lender in case you stop making payments; it does not protect you. The most important point to remember: Tracking how soon you are eligible to get rid of PMI and making sure your lender eliminates it can save you significant money. It’s worth the effort.