Buying your first home is an exciting time in life. To make the process easy, you want to be sure you do everything right on time to make sure it doesn’t drag out for weeks on end. One of the things that will drag it out for several months is if you fail to make your mortgage payment on time. You need to be sure you’re avoiding PMI (Private Mortgage Insurance) with every trick at your disposal. Read through this article for some great advice about how to avoid pmi.
Private mortgage insurance (PMI) is an insurance policy that protects lenders from the risk of default and foreclosure. Generally, if you need financing to buy a home and make a down payment of less than 20% of its cost, your lender will probably require you to buy insurance from a PMI company prior to signing off on the loan. Although it costs extra, PMI allows buyers who cannot make a significant down payment (or those who choose not to) to obtain financing at affordable rates.
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How Not to Pay PMI
Option 1: Pay down your mortgage for automatic or final termination of PMI
The federal Homeowners Protection Act gives you the right to remove PMI from your home loan in two ways:
- You can get “automatic” or “final” PMI termination at specific home equity milestones.
- You can request to remove PMI when you reach 20 percent home equity.
The lender or servicer must automatically terminate PMI when your mortgage balance reaches 78 percent of the original purchase price — in other words, when your loan-to-value (LTV) ratio drops to 78 percent. This is provided you are in good standing and haven’t missed any mortgage payments.
The servicer also must stop the PMI at the halfway point of your amortization schedule. For example, if you have a 30-year loan, the midpoint would be after 15 years. If you have a 15-year loan, the halfway point is 7.5 years.
The servicer must cancel the PMI then — depending on whether you’ve been current on your payments — even if your mortgage balance hasn’t yet reached 78 percent of the home’s original value. This is known as final termination.
Who this affects: Removing PMI in this way works for folks with conventional mortgages who have paid according to their original payment schedules and have reached the milestones of 22 percent equity or the halfway point in time. To be eligible, you must be up to date on your payments.
Option 2: Request PMI cancellation when mortgage balance reaches 80 percent
Instead of waiting for automatic cancellation, you have the right to request that the servicer cancel PMI once your loan balance reaches 80 percent of the home’s original value. If you’re making payments as scheduled, you can find the date that you’ll get to 80 percent on your PMI disclosure form (or you can request it from your servicer).
If you have the cash to spare, you can get there faster by making extra payments.
You can prepay the principal on your loan, reducing the balance, which helps you build equity faster and save on interest payments. Even $50 a month can mean a dramatic drop in your loan balance and total interest paid over the term of the loan.
Some borrowers choose to apply a lump sum toward their principal or even make an extra mortgage payment per year. That will get you to the 20 percent equity level faster. To estimate the amount your mortgage balance needs to reach to be eligible for PMI cancellation, multiply your original home purchase price by 0.80.
Who this affects: Homeowners can use this method once they have achieved 20 percent equity. You must also do the following to cancel PMI:
- Make the PMI cancellation request to your lender or servicer in writing.
- Be current on your mortgage payments, with a good payment history.
- Meet other lender requirements, such as having no other liens on the home (i.e., a second mortgage).
- If required, you might need to get a home appraisal. If your home’s value has declined, that would mean you have yet to reach that 20 percent equity and might not be able to cancel PMI.
Option 3: Refinance to get rid of PMI
When mortgage rates are low, you might consider refinancing your mortgage to save on interest costs or reduce your monthly payments. At the same time, refinancing might enable you to eliminate PMI if your new mortgage balance is below 80 percent of the home value. It’s a double dose 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 risen 15 percent since then, 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.
With any refinancing, you’ll want to weigh the closing costs of the transaction against your potential savings from the new loan terms and eliminating PMI.
Who this affects: This strategy works well in neighborhoods where home values are on the upswing. If your home value has declined, refinancing could have the opposite effect — you might be required to add PMI if your home equity has dropped.
Refinancing to get rid of PMI typically doesn’t work well for new homeowners. 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 two years old, you can ask for a PMI-cancelling refi, but you’re not guaranteed to get approval.
Option 4: Reappraise your home if it has gained value
In a hot real estate market, your home equity could reach 20 percent ahead of the loan payment schedule. In this case, it might be worth paying for a new appraisal. If you’ve owned the home for at least five years, and your loan balance is no more than 80 percent of the new valuation, you can ask for PMI to be cancelled. If you’ve owned the home for at least two years, your remaining mortgage balance must be no greater than 75 percent.
Appraisals for a single-family home typically cost between $250 and $500, depending on your area. Some lenders might be willing to accept a broker price opinion instead, which can be a substantially cheaper option than a professional appraisal. On the flip side, professional appraisals are highly regulated and provide an unbiased assessment.
Who this affects: Borrowers who live in areas that are particularly red-hot might have seen their home values shoot up in the last couple years. In fact, the value might have increased enough to bump you out of the PMI range. If this is the case, it’s time to talk with your lender about getting a new appraisal and potentially cancelling your PMI requirement.
If you’ve added amenities or renovated your home, that might have increased the value, as well, which could also mean more equity. Whether it’s a renovated kitchen, replacement windows or an extra room, common upgrades like these can increase your home’s value. If you cross the 20 percent equity finish line in the process, then you can kick PMI to the curb.
Several ways exist to avoid PMI:
- Put 20% down on your home purchase
- Lender-paid mortgage insurance (LPMI)
- VA loan (for eligible military veterans)
- Some credit unions can waive PMI for qualified applicants
- Piggyback mortgages
- Physician loans
There are a few things to note about the above options.
With LPMI, the lender pays the PMI cost, but will most likely provide you with a higher mortgage rate. Also, LPMI does not get eliminated like PMI eventually does.
With a piggyback mortgage, buyers can use two loans instead of one (piggyback) to purchase a home. The first is a traditional mortgage loan. The second includes either a home equity line of credit or a standard home equity loan. The second loan covers the remaining amount to obtain the 20% down payment and usually has a higher rate.
Conclusion
Whether you’re aiming to refinance your house or whether you’re looking to buy a home, chances are you’ll be required to make private mortgage insurance (PMI) payments.