When it comes to buying or refinancing a home, the first questions that typically come to mind are the ones associated with interest rate, monthly payment, and closing costs.
After that, the next question a home buyer will typically ask themselves is: “How much will I need to put down?”.
Many people still think a 20 percent down payment is required in order to purchase a home. However, it’s possible to buy a home while putting down less thanks to private mortgage insurance.
What exactly is private mortgage insurance (PMI)?
Although many homeowners may beg to differ, private mortgage insurance (PMI) isn’t such a bad thing.
Because of PMI, down payments of less than 20 percent make home buying a reality for people that wouldn’t otherwise have the opportunity to become homeowners.
There are varying types of mortgage insurance required depending on the mortgage program used.
Private mortgage insurance is a mandatory insurance policy for conventional loans. It is required by the lender and paid for by the homeowner to insure the lender should the homeowner default on their mortgage payments.
PMI is required on conventional loans when the homeowner is making a down payment of less than 20 percent. You will also need PMI on conventional refinance loans if you have less than twenty percent equity in your home.
When and how can I remove PMI from my loan?
Fortunately for homeowners with conventional loans, private mortgage insurance won’t be part of your mortgage payment forever.
The Homeowners Protection Act requires that lenders send homeowners annual notices that remind you that you have the right to request the cancellation of your PMI.
As a homeowner, you can request that the mortgage insurance be removed when you have reached the date when the principal balance of your mortgage falls to 80 percent of the original value of your home.
Even if you do not request it be removed, lenders are required to cancel PMI automatically on conventional loans once you’ve reached the date when your principal balance reaches 78 percent of the original value of your home.
You should be able to locate these dates on your closing paperwork. More specifically, you should have a PMI disclosure form that you signed when you closed on your home loan.
You can request that your PMI be dropped earlier than these dates if you meet the following criteria:
- You must be up-to-date on your monthly payments.
- Your request must be in writing.
- You may need to certify that you do not have any 2nd mortgages on your home.
- It may be necessary that you provide an appraisal to support the value of your home.
Generally, assuming you meet these requirements, your lender must cancel your PMI.
It is important to note that some lenders have a minimum requirement. That means you will have to wait at least two years before being able to get rid of your mortgage insurance.
Refinancing to get out of paying PMI
It is estimated that there are more than six million homeowners in the U.S. that are eligible to refinance their mortgages. With home values rising and mortgage rates holding at low levels, refinancing is a smart option for many homeowners.
Refinancing your existing mortgage can be beneficial for a variety of reasons. For example, homeowners may be interested in refinancing to get a lower interest rate, to shorten their term, or to remove their mortgage insurance.
Let’s say you purchased your home four years ago for $200,000, and financed $180,000 at 3.875%.
Due to putting down 10 percent, this means you had a loan-to-value ratio of 90 percent and you are paying mortgage insurance.
Four years later, after making all your payments on time, you now owe approximately $166,000.
Now let’s assume your home has appreciated at a rate of five percent per year. This means your home is now valued at roughly $240,000.
- $166,000 divided by $240,000 equals a loan-to-value of 69 percent.
This is well below the 80 percent mark and means you may be able to refinance into a new loan to remove your PMI.
Getting rid of PMI
If you put less than 20 percent down when you purchased your home, or if you refinanced with less than 20 percent equity, you are required to pay mortgage insurance.
Fortunately, you can remove it after you have met a few conditions.
Mortgage insurance can be expensive, especially if paid over many years. However, for many people, PMI is a good thing. Without it, homeownership wouldn’t be possible.