If you're considering a home equity loan to finance renovations, college expenses, or another big expense, you might be wondering if it will affect your private mortgage insurance (PMI). After all, premiums for PMI are based on your loan-to-value (LTV) ratio, a measure that compares the amount of your mortgage to your property's value. And because a home equity loan can change your LTV, it can also change how long you'll be on the hook for PMI.
- Conventional mortgage lenders generally require PMI if your down payment is less than 20%.
- PMI premiums are based on your loan-to-value (LTV) ratio, which compares your mortgage balance to your home's value.
- A home equity loan lets you tap into your home's equity without selling or refinancing the house.
- Because a home equity loan can change your LTV ratio, it can affect your PMI.
What Is a Home Equity Loan?
A home equity loan—sometimes called a second mortgage—lets you tap into your equity without selling or refinancing the house. Your lender gives you a lump-sum payment that you repay with interest over a fixed term. The amount you borrow and the interest rate you pay depend on several factors, including your income, credit history, and your home's current market value. Most lenders let you borrow up to 80% to 85% of the equity you've built in the house, though some lenders will lend even more.
What Is Private Mortgage Insurance (PMI)?
Your lender may require you to buy PMI if you have a conventional loan and your down payment is less than 20%. Like other mortgage insurance products, PMI protects the lender (not you) should you stop making mortgage payments and default on the loan. PMI premiums are included in your monthly mortgage payment or paid upfront with a one-time premium at closing—or a combination of the two.
If you have a Federal Housing Administration (FHA) loan, you won't have PMI. Instead, you'll pay an upfront FHA mortgage insurance premium (MIP) at closing equal to 1.75% of the loan, and in most cases, an annual MIP for the entire loan term.
What Is the Loan-to-Value (LTV) Ratio?
The LTV ratio compares your mortgage amount to your home's value. It's calculated by dividing your loan balance by your home's value. For example, if your home is valued at $400,000 and your loan balance is $300,000, your LTV ratio would be 75% ($300,000 / $400,000).
Lenders use LTVs to determine their risk in lending money, with higher LTVs viewed as riskier loans. The lower your LTV, the more likely you'll get approved with favorable interest rates. You can lower your LTV by making a larger down payment or buying a less expensive home.
How Do You Get Rid of PMI?
Thanks to the Homeowners Protection Act, there are three ways to remove PMI from your loan:
- Request PMI cancellation. You can ask your lender to cancel PMI when you reach the date the principal balance of your loan is scheduled to fall to 80% of the home's original value, or if you've made extra mortgage payments that brought the balance down to 80%. You can also ask your lender to cancel PMI if your equity reaches at least 20% due to rising property values or improvements you've made to the home—but you'll need an appraisal to prove your case.
- Automatic PMI termination. Your lender must terminate PMI on the date your principal balance is scheduled to reach 78% of the original value, provided you're current on payments.
- Final PMI termination. Another way to end PMI is to reach the midpoint of your loan's amortization schedule—for example, 15 years of a 30-year mortgage. This is most likely to happen if you have a mortgage with an interest-only period, principal forbearance, or a balloon payment.
The "original value" is the sales price or appraised value of the home when you bought it, whichever is lower.
Does a Home Equity Loan Affect PMI?
If your PMI has already been canceled, your lender can't reinstate it. So, in this case, a home equity loan will not affect PMI.
However, if you're still paying PMI, a home equity loan will increase your LTV ratio—and the amount of time you'll be required to pay PMI. That's because it will take longer for your principal balance to drop to 80% (in the case of a cancellation request) or 78% (for an automatic termination).
Having PMI on your first mortgage can also potentially limit the size of your home equity loan because PMI increases your debt load, meaning you can afford to borrow less on a new loan.
When Is Private Mortgage Insurance Required?
Private mortgage insurance is usually required if you have a conventional loan and your down payment is less than 20% of the home's purchase price. It's also necessary if you're refinancing with a conventional loan and have less than 20% equity in your home.
How Much Can You Borrow on a Home Equity Loan?
Most lenders let you borrow up to 80% of the equity in your home, depending on your income, credit history, and your home's current value.
Can I Deduct Home Equity Loan Interest?
You can only deduct the interest you pay on a home equity loan if you use the money to buy, build, or substantially improve your home. Still, because the standard deduction increased under the Tax Cuts and Jobs Act, you might not come out ahead by itemizing home equity loan interest on your tax return.
What Is a HELOC?
A home equity line of credit (HELOC) lets you borrow against the equity in your home, but it differs from a home equity loan. With a home equity loan, you borrow a set lump sum that you repay with a fixed interest rate and a fixed payment. Conversely, a HELOC is a revolving line of credit with variable interest rates and payments.
The Bottom Line
A home equity loan will increase your LTV and likely extend the amount of time you're under the burden of PMI. To get rid of PMI faster, you can make two mortgage payments a month (if your lender allows), bump up your monthly payment, or make an extra payment when you fall into some money—for instance, a tax refund. You can also make improvements to your home that increase its value.
If you're considering a home equity loan, ask your lender how it would affect your PMI premiums before making any decisions.