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If you are in the market to buy a new home and have less than a 20 percent down payment, you are usually required to buy private mortgage insurance.
Overview of PMI
Private mortgage insurance (PMI) is a mandatory mortgage insurance you have to pay when you take out a conventional loan. PMI protects the lender in the case you cannot make your mortgage payments.
The lender arranges this coverage and private insurance companies provide the insurance. It is usually required if you take out a conventional loan, but you have a less than 20 percent down payment of the purchase price or value of the home. It is also required if you are refinancing your house, but you do not have at least 20 percent equity in your home. PMI costs vary depending on several factors of the loan.
Avoiding PMI
There are several ways to get around PMI. Sometimes lenders will offer conventional loans that don't require PMI, even if you have less than 20% down. With these loans, you may pay a higher interest rate, which can often be more expensive than the PMI itself. Not paying PMI and paying more in interest rates could affect your taxes and your long term financial plan, so it is a good idea to talk to your tax advisor before deciding which way is best for you. Mortgage insurance, like mortgage interest, is currently tax deductible. In some cases, you might be able to take out two loans – a first mortgage and a second mortgage – to avoid paying PMI. It is important to compare these different options with your lender.
Another option you have if you have a small down payment is taking out a different loan like an FHA loan. Loans like this could end up being more or less expensive than a PMI required conventional loan, depending on your down payment, credit score, general market conditions, and lender. FHA loans, however, have mortgage insurance premiums for the life of the loan. You need to refinance to another loan program in order to remove the mortgage insurance from your payment. The best way to avoid PMI is to save up your money until you can put 20 percent down on the house. PMI is not required if you pay the 20 percent down.
Getting Rid of PMI
Once the principal balance of your loan drops to 80 percent of your home's original appraised value, you can ask to have the PMI canceled. In order to remove the PMI, you must have made all your payments on time and made at least 24 months of payments. You would need to request removal of the PMI in writing to the loan servicer. Once approved, your payment will be adjusted to remove the PMI from your monthly amount payable. Once you have 22% equity in your property, the PMI will automatically drop off provided you have made all payments on time.
The steps you can to take to cancel your PMI sooner include:
- Refinance: To have PMI removed, you will need at least 20 percent equity in your home. If home prices in your area have been noticeably increasing, you will have built additional equity in your home. Refinancing with a better loan-to-value may put you past the 20 percent threshold.
- Have your home appraised again: To see if you now meet the 20 percent equity threshold, some lenders may allow for a new appraisal rather than going by the original sales price.
- Make prepayments on your loan: Even small payments a month added to your regular mortgage payment can help you get your loan balance down quicker.
- Remodel: Consider adding an additional room to increase the market value of your home. Then ask your lender to use the new value figure to recalculate your loan-to-value ratio.
When the market is experiencing near record low mortgage rates, refinancing will not just eliminate your PMI but will lower your interest payments each month as well.
You can still buy a home even if you do not have 20 percent down. Conduct research to learn more about how PMI works and when you will be able to eliminate yours.
