How can I avoid paying private mortgage insurance (PMI)?
Private mortgage insurance (PMI) is an insurance policy that protects lenders from the risk of default and foreclosure, and allows buyers who cannot make a significant down payment (or those who choose to not to) 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 prior to signing off on the loan.
One way to avoid paying PMI is to make a down payment that is equal to at least 20% of the purchase price of the home. If your new home costs $180,000, for example, you would need to put down at least $36,000 to avoid paying PMI. While that's the simplest way to avoid PMI, a down payment that size may not be feasible.
Another option for qualified borrowers is a piggyback mortgage. In this situation, a second mortgage or home equity loan is taken out at the same time as the first mortgage. With an "80-10-10" piggyback mortgage, for example, 80% of the purchase price is covered by the first mortgage, 10% is covered by the second loan, and the final 10% is covered by your down payment. This lowers the loan-to-value (LTV) of the first mortgage to under 80%, eliminating the need for PMI. For example, if your new home costs $180,000, your first mortgage would be $144,000, the second mortgage would be $18,000, and your down payment would be $18,000.
A final option is lender-paid mortgage insurance (LMPI) where the cost of the PMI is included in the mortgage interest rate for the life of the loan. Therefore, you may end up paying more in interest over the life of the loan.
PMI is required on a home purchase where the down payment is less than 20%. So, PMI can be avoided by increasing the down payment on a home to 20%. Also, the lender is required to remove PMI once the loan's value decreases to more than 78% of the original loan value. While it may take a few years, you can keep up with your amortization schedule and notify the lender when the loan payoff reaches the 78% point.
PMI may not be something you can avoid if you don't have enough money to put down on the house, which you need at least 20% to put down.
You can have a second loan that can take care of the PMI, but sometimes there isn't much of a cost difference.
If you can't avoid private mortgage insurance, there is one thing you can do to get rid of the PMI earlier. One of the things you can do is monitor your home value. Maybe you did a small home improvement where you added a bathroom or bedroom. As of late, home prices have been increasing which means your home value could be worth more than when you purchased it. Interest rates are still at all time lows, so you could refinance your house. When you refinance, your house will be revalued at the new market rates which could put your mortgages to home value above the 20% mark.
For example, lets say you bought a house for $350,000 in 2014 and your house was valued at $350,000. You put $30,000 down so you are still far away from getting rid of PMI because your mortgage is $320,000. However, a year or two later, the housing market has improved and your house is now worth more than $400,000. Interest rates haven't changed much so looking at refinancing to get rid of PMI may be worth looking at. When you go to refinance, they will assess your house at the new market value of $400,000, and your mortgage is still around $320,000 or less, which makes your equity now 20%. You have now removed the PMI from your mortgages. Before you do this, make sure when you refinance, your payment is less than what you originally were paying and make sure to talk to a mortgage broker to make sure it is worth looking at.
Vincent Oldre, CFP®
HOW TO GET RID OF PMI?
To avoid or remove PMI, or private mortgage insurance, you must have at least 20 percent equity in the home. You may ask the lender to cancel PMI when you have paid down the mortgage balance to 80 percent of the home's original appraised value. When the balance drops to 78 percent, the mortgage servicer is required to eliminate PMI. If you bought a house with a down payment of less than 20 percent, your lender required you to buy mortgage insurance. The same goes if you refinanced with less than 20 percent equity. Private mortgage insurance is expensive, and you can remove it after you have met some conditions. Although you can cancel private mortgage insurance, you cannot cancel Federal Housing Administration insurance. You can get rid of FHA insurance by refinancing into a non-FHA-insured loan.
CAN YOU CANCEL YOUR PMI SOONER?
Here are steps you can take to cancel mortgage insurance sooner or strengthen your negotiating position:
- Refinance: If your home value has increased enough, the new lender won't require mortgage insurance.
- 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 percent equity threshold. An appraisal generally costs $450 to $600. Before spending the money on an appraisal, ask the lender if this tactic will work in the specific case of your loan.
- 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.
CAN YOU REFINANCE TO GET OUT OF PMI?
When mortgage rates are low, as they are now, refinancing can allow you not only to get rid of PMI, but to reduce your monthly interest payments. It's a double-whammy of savings. The refinancing tactic works if your home has gained substantial value since the last time you got a mortgage. For example, if you bought your house four years ago with a 10 percent down payment, and the home's value has gone up 15 percent over that time, you now owe less than 80 percent of what the home is worth. Under these circumstances, you can refinance into a new loan without having to pay for PMI. Many loans have a "seasoning requirement" that requires you to wait at least two years before you can refinance to get rid of PMI. So if your loan is less than 2 years old, you can ask for a PMI-canceling refi, but you're not guaranteed to get approval.
WHAT IS PRIVATE MORTGAGE INSRUANCE PMI NEEDED?
Mortgage insurance reimburses the lender if you default on your home loan. You, the borrower, pay the premiums. When sold by a company, it's known as private mortgage insurance, or PMI. The Federal Housing Administration, a government agency, sells mortgage insurance, too.
DO YOU KNOW YOUR RIGHTS?
By law, your lender must tell you at closing how many years and months it will take you to pay down your loan sufficiently to cancel mortgage insurance. Mortgage servicers must give borrowers an annual statement that shows whom to call for information about canceling mortgage insurance.
WHAT ARE THE 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.
HIGHER-RISK PROPERTIES (LIKE RENTAL/INESTMENT PROPERTIES)
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.
BASICS FOR FIRST TIME HOME-BUYERS
FINANCING BASICS FOR FIRST TIME HOMEBUYERS
Many people who are considering buying their first home can be overwhelmed by the myriad of financing options available. Fortunately, by taking the time to research the basics of property financing, homeowners can save a significant amount of time and money. Having some knowledge of the specific market where the property is located and whether it provides incentives to lenders may mean added financial perks for buyers. Buyers should also take a look at their own finances to ensure they are getting the mortgage that best suits their needs.
There are a couple of options to avoid the PMI on your mortgage. If you put 20% as a down payment, then usually the PMI is not a factor. If you put less than the 20% down, PMI will be in effect until your equity reaches 20% of the original loan value. There are also some mortgages that will not require PMI, but you could be paying a higher interest rate.
Kim Howard, CFP