It’s not always possible to make a 20% down payment on a home loan, but if you pay less, you may be required to pay private mortgage insurance. However, PMI can lower a cost barrier for prospective borrowers, allowing you to become a homeowner and begin building equity sooner.
Of course, that doesn’t mean PMI is always worth it. After all, it’s an added cost that doesn’t contribute to the equity in your home. Here’s how it works and how to get rid of PMI when you no longer need it.
How Private Mortgage Insurance Works
Private mortgage insurance, or PMI, is a type of financial protection mortgage lenders require when the borrower has a lower down payment — usually less than 20% for a conventional loan. PMI may also be required if you refinance your mortgage with less than 20% equity built up. That’s because the smaller the down payment, the riskier the loan. The homebuyer has to borrow more to cover the value of the home, resulting in a higher payment. And with little equity built up in the property, the lender could end up taking a loss if it turns out that the borrower can’t afford the loan.
“PMI is a type of mortgage insurance policy that provides compensation by the insurance company to the lender, in the event a borrower defaults on the mortgage,” says Laura M. Endres, an attorney focused on real estate law with Taylor, Eldridge & Endres in Smithtown, New York.
[Read: Best Mortgage Lenders.]
According to Endres, PMI doesn’t protect the borrower from having to pay the mortgage if they are unable to do so.
“It is an insurance policy only for the lender and has no benefit to the borrower,” she says, “other than to allow a borrower who would not normally qualify for a mortgage to be approved for a mortgage.”
Third-party private mortgage insurance companies generally provide PMI policies, and the lender arranges and tacks the premium onto the mortgage payment. You continue to pay PMI until you’ve built up enough equity in your home. Typically, lenders require a minimum loan-to-value ratio — which is the total amount borrowed divided by the value of the property — of 80% before PMI can be removed.
Say you purchased a home for $200,000. However, you only put down 10%, or $20,000. That means your LTV would be 90%, requiring you to pay PMI. Until you’ve made enough mortgage payments so that your balance reaches $160,000 — or your home is reappraised at a higher value — you will have to pay PMI.
On conventional mortgage loans, PMI generally ranges from 0.3% to 1.5% of the original loan amount each year, depending on your credit score and down payment. On a $200,000 mortgage, a 1% PMI premium would cost you $2,000 per year, or $167 per month.
Know Your Rights
Getting rid of PMI once you’re eligible isn’t just something mortgage lenders voluntarily allow — it’s required by federal law in many instances. As a borrower, you’re protected under the federal Homeowners Protection Act, which dictates when lenders must remove PMI.
First, you have the right to request the removal of PMI when your principal loan balance is scheduled to fall below 80% of your home value. You can find this date on your PMI disclosure form that you should receive when you first take out your mortgage. If you can’t find it, contact your lender.
You can also request that PMI be canceled early if you’ve made extra mortgage payments to reduce the principal balance to less than 80% of your home value.
For a PMI cancellation request to be valid:
— The request must be made in writing.
— Your mortgage must be in good standing.
— In some cases, you must also show that there are no liens against the property, and that your home’s value hasn’t dropped below the original appraised value.
If you don’t reach out to remove your PMI, the lender must automatically cancel it on the date when the principal balance is scheduled to reach 78% of your home’s value. If this hasn’t happened by the time you’ve reached the midpoint of your loan’s amortization schedule, the lender must cancel your PMI at this point. Again, you must be current on your payments.
How to Get Rid of PMI
PMI is an added cost that makes your mortgage more expensive, so you want to get rid of PMI payments as soon as possible.
1. Find out if you automatically qualify. The good news is that once you reach an LTV of 78% percent — or 22% percent equity in your home’s value at the time of purchase — your lender is required to automatically cancel PMI, even if you don’t formally request it. However, you should verify that the PMI has, in fact, been canceled as soon as you become eligible.
2. Meet the requirements. If you’re not in a position to have your PMI canceled automatically, you may be able to request it. First, you’ll have to meet a few requirements, including an 80% LTV in most cases.
3. Make the request. Once you’ve verified that you meet the requirement to have PMI canceled, you can make the request to your lender. Remember, this needs to be done in writing.
4. Refinance your mortgage. This involves taking out a new loan with new terms and using the loan proceeds to pay off your old mortgage. If you have at least 20% equity in your home at the time of refinancing, the new loan will not include PMI. Keep in mind that refinancing usually comes with closing costs, whereas simply requesting PMI cancellation is free. So you should only go this route if refinancing will help you in some other way as well, such as lowering your interest rate.
[Read: Best Mortgage Refinance Lenders.]
Government Loans and Mortgage Insurance
If you take out a mortgage through certain government programs, the rules on mortgage insurance differ.
Do FHA Loans Have PMI?
The Federal Housing Administration provides mortgage insurance on loans made by FHA-approved lenders. In fact, FHA mortgage borrowers can put down as little as 3.5%, depending on their credit score. However, FHA mortgage insurance is required for all FHA loans, regardless of down payment size or credit score.
FHA mortgage insurance comes in the form of both an upfront charge that’s paid along with other closing costs or rolled into the total loan amount, as well as a monthly fee that’s included in the mortgage payment. “It’s important to note that most FHA borrowers financing with FHA loans have the mortgage insurance for the life of the loan,” says Scott Griffin, a mortgage broker with Scott Griffin Financial.
Usually, the only way to get rid of the mortgage insurance premium on an FHA loan is to refinance the loan with a non-FHA lender, according to Shawn Sidhu, branch manager and mortgage broker with C2 Financial Corp. of California.
[Read: Best FHA Loans.]
Do USDA Loans Have PMI?
Mortgage loans backed by the U.S. Department of Agriculture require mortgage insurance in the form of both an upfront fee and a monthly payment. And like FHA loans, you can roll the upfront portion into your mortgage instead of paying it at closing, but doing that increases the size of your loan and therefore the monthly payment and total interest paid.
DO VA Loans Have PMI?
U.S. Department of Veterans Affairs loans don’t require a monthly mortgage insurance premium, but they do typically require an upfront VA funding fee that varies depending on your type of military service, down payment amount and other factors. Like other government-backed loans, you may roll that fee into your mortgage or pay it at closing. “There are instances where a veteran may be exempt from the VA funding fee, typically due to a service-related disability,” Endres says.
How to Cancel PMI Early
There are a couple of instances when you might be able to get rid of PMI ahead of schedule, including:
— If your home has appreciated in value. You could request to cancel PMI if your property has appreciated significantly, according to Sidhu. In this case, you might not have made many mortgage payments, but the LTV still decreased to an acceptable level, thanks to the increased equity in the home.
— If you’ve made extra mortgage payments. By paying down your mortgage aggressively and making larger or extra payments, you’ll speed up the timeline to reaching 80% LTV. Of course, you’ll need to consider whether putting extra funds toward your mortgage is more financially advantageous than other options, such as investing in the market.
— If you meet certain conditions. Although mortgage insurance premiums are required for the entire term of FHA loans in many cases, Endres points out that there are a couple of instances in which you can get it canceled. If you took out your mortgage between Dec. 31, 2000, and June 3, 2013, and the LTV is 78% or less, you can contact the lender and request to have the mortgage insurance removed. If you took out the mortgage after June 3, 2013, and put more than 10% down, the mortgage insurance can be removed after 11 years.
“Cessation of PMI is dependent on other factors, such as a good payment history,” Endres says. She encourages borrowers to understand their rights regarding what date they may ask for the PMI to be terminated and to make sure it’s on their calendars.
What Is a No-PMI Mortgage?
When shopping around for a mortgage, you may come across something called a no-PMI mortgage. This is exactly what it sounds like — a mortgage loan that doesn’t require PMI, even if you don’t have a 20% down payment. These are offered at the discretion of individual financial institutions.
If you come across a no-PMI mortgage, be sure to verify that the institution is legitimate and has good reviews. And keep in mind that even if you don’t have to pay PMI, putting a smaller amount down can cost you in other ways, such as a higher interest rate and bigger monthly payment.
Ultimately, if you’re considering taking out a mortgage, it’s important to do the math and decide whether or not paying PMI makes financial sense for you.
More from U.S. News
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When Should You Refinance an Adjustable-Rate Mortgage?
How to Get Rid of PMI originally appeared on usnews.com
Update 07/28/23:
