For many homebuyers, especially first-timers, coming up with the down payment is the big hurdle. Ideally, that down payment will be more than 20% of the total price of the house you buy.
However, not everyone can scrape that together: enter private mortgage insurance (PMI).
If you have it, you know it, as it isn’t cheap and it’s part of your monthly payment. Wouldn’t it be nice to get rid of it? Just imagine the money you’d save, especially if you put that money into a savings account. Well, here’s how to stop dreaming and make those savings a reality.
First, what is PMI?
PMI is an insurance policy that you (usually) must buy if your down payment is less than 20% of the value of your home. That puts you in a risky category in the eyes of even the best mortgage lenders, who are concerned that you won’t be able to keep up with your mortgage payments.
In the event that you default, the PMI provider steps in and pays off your debt to the lender, insulating them from the fallout of default. However, bear in mind that PMI will not benefit you in any way if you can’t afford your home. Private mortgage insurance protects the lender.
How much PMI costs you
PMI can cost a lot — approximately 0.3% to 1.5% of the amount of your mortgage. Those numbers may sound small, but when you factor in the size of your home loan, the money can really add up.
Given that the average mortgage in the United States is currently more than $450,000, that puts PMI at between $13,500 to $67,500 over the life of the loan. We don’t know about you, but to us, that is a lot of money.
Fortunately, as your home equity grows, you can ditch PMI and put that money to a better use.
Keep making payments until PMI is automatically canceled
Perhaps the most straightforward way to get rid of PMI is to stay on top of your monthly mortgage payments. Even if you don’t really understand your mortgage or are just confused by numbers, making your payments diligently and on time will eventually render PMI obsolete.
Federal laws in place dictate when PMI has to be canceled for homeowners. That happens when you reach 20% equity in your home, which was the benchmark that required PMI in the first place. PMI must also be canceled when you reach the midway point of your mortgage payment schedule, which is likely 15 years for a 30-year loan or 7.5 years for a 15-year loan.
While PMI should be jettisoned automatically, you should still stay on top of how much you’ve been paying and when those payments are set to end. You can do this by contacting your mortgage lender or looking at your mortgage loan statement, as PMI costs are rolled into your monthly payments.
Ask for cancellation when you reach 80% of your mortgage
If you want to get your PMI canceled sooner and put that money in the best savings account, start tracking when you will hit another magic number (besides the 20% point).
Ascertain when your remaining mortgage is 80% of the original total value of your residence. This is your loan-to-value (LTV) ratio. Again, this requires diligence on your part to track when you’ll hit that benchmark. That’s when you can write a letter to your bank requesting that your PMI payments be stopped.
You can also take steps to get to 80% by making extra payments on your mortgage balance. Make sure that these payments go toward principal (and not interest), as that is a quicker way to increase your equity. You’ll want to have proof of your consistent mortgage payment schedule.
To ask for a cancellation, you can’t have any other liens, such as a second mortgage or home equity loan, on your home. You may need to have your house appraised if proof of value is requested, too.
Refinance your mortgage if equity has increased
Another tactic you can use to get rid of PMI is to refinance your home, which can help you hit that 80% sweet spot with your new balance. You might even wind up with both a lower interest rate and smaller payments, too. However, there are several things to consider to find out if this strategy is right for you.
First, make sure that your home’s value hasn’t decreased since you purchased it. That would only put you in a worse situation, potentially with a new PMI policy. Instead, find solid evidence that the value of your home has gone up. As long as that’s the case, the refi will work in your favor.
Second, determine that whatever it would cost to refinance — consider closing costs, especially — wouldn’t outweigh any benefits of the refi.
Finally, refinancing to eliminate PMI may simply not be an option for homeowners on the newer side, thanks to what’s called a “seasoning requirement,” which many mortgages have. This becomes a non-issue after two years, though.
Get a new appraisal on your home’s worth
If the value of your home has increased, you may be able to get rid of PMI by getting a new appraisal. (Again, this isn’t a wise idea if the opposite is true.) The value of your home could have increased because the real estate market is hot, the residences in your neighborhood have gone up in value, or you invested money in a home renovation.
If you go this route, make sure you consult with your mortgage holder before you pull any levers. They may require that you have the appraisal done by a specific person. You may even be able to use what’s called a “broker price opinion,” which is both less expensive and faster.
Finally, bear in mind that if you are only two years into the life of your loan, your loan-to-value ratio must be 75%, and if you’re five years in, the LTV rises to 80%.
Once you’ve successfully gotten rid of PMI, take that money and put it in a savings account with a good return on investment. That way you can either save up for something fun like a vacation, or something prudent like retirement. Congratulations on your financial wizardry!
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