Did you buy a house with less than 20 percent down? If you did, chances are you’re currently paying private mortgage insurance (PMI). But how can you get rid of it to keep more of your hard-earned money in your pocket? Keep reading to learn more about how PMI works and how to ax the added expense from your monthly mortgage payment.
What is PMI (Private Mortgage Insurance)?
PMI protects the lender if you fall behind on loan payments and are forced to foreclose on the home. This insurance policy doesn’t always come up, but lenders will add it to your monthly expenses if you put less than 20% down on your home purchase.
There are two forms of PMI:
- Borrower-Paid Mortgage Insurance (BPMI): With BPMI, the premiums are added to your monthly mortgage payment. It remains intact until you have at least 20 percent equity built up in your home and reach out to have BPMI canceled.
- Lender-Paid Mortgage Insurance (LPMI): The premiums won’t be included in your monthly mortgage payment. Instead, you’ll get a higher interest rate, and there’s another downside. Unlike BPMI, you won’t be able to cancel coverage once you reach 20 percent in equity unless you refinance your mortgage. However, you can choose to make a payment towards your PMI at the closing table. In this case, you’d get a better interest rate on your mortgage. But if you opt to pay your entire LPMI upfront at closing, you will get the interest rate that you would’ve qualified for had you made a down payment of 20 percent or more.
Is PMI Mandatory?
PMI, whether it’s BPMI or LPMI, is mandatory on conventional loans if you put less than 20 percent down.
If you have an FHA (Federal Housing Administration) loan, you’ll be responsible for mortgage insurance premiums (MIP) for the life of the loan if your down payment is below 10 percent. However, if you make a down payment above 10 percent, you will only have PMI on your FHA loan for 11 years.
You can avoid PMI by making a 20% down payment on a conventional mortgage. While this savings goal prolongs the amount of time it will take to buy a home, you can save over $1,000 every year. Putting more money down will also lower your monthly mortgage payments. You cannot avoid private mortgage insurance for an FHA loan, even if you put more than 20% down.
What Does PMI Cover?
PMI protects the lender if you encounter financial hardship and default on your home loan payments. Of course, the lender takes a risk with any loan, but the risk becomes more significant if more than 80% of the loan remains unpaid. Unfortunately, PMI doesn’t offer protections to borrowers.
How Much Does PMI Cost?
PMI costs are determined by your loan type, debt-to-income ratio (DTI) ratio, down payment and credit score. Generally, you’ll pay roughly 0.1 to 2 percent of your total loan amount annually in PMI premiums.
A higher credit score means you’ll likely pay less for PMI since the chances of defaulting on your home loan are lower. But if your credit score is on the lower end, expect higher premiums to offset the risk of foreclosure that the lender assumes.
The same rule applies to fixed-rate loans since their monthly payments are set in stone and are far easier for mortgage lenders to estimate. But adjustable-rate mortgages come with fluctuating interest rates, which means your monthly payment will change over time.
How to Get Rid of PMI
When the time comes, you can kiss PMI goodbye forever. Or you can refinance to get rid of PMI and give your budget some relief. Below is a closer look at each strategy and how it works.
Wait for Automatic Cancellation
The lender may automatically move forward with PMI cancellation on your behalf once your loan is eligible. This method only works for conventional mortgages when you reach 22% equity. You can get it canceled when you reach 20% equity by making a call, but lenders automatically cancel your PMI when you reach 22% equity on a conventional mortgage.
Request to Cancel Your PMI
Reach out to your mortgage servicer by phone or submit a written request to request PMI cancellation once you reach 20 percent equity in your home. You can only request to cancel your PMI if you have a conventional mortgage. Your mortgage provider will cancel PMI on your conventional mortgage once you reach 22 percent equity, but why wait until then when you can get it removed upon reaching 20 percent equity?
Request for a New Appraisal
You can also request an appraisal to determine if your home’s value has appreciated and if you now have at least 20 percent in equity. It is possible to reach 20% in home equity before you contribute enough funds to reach 20% of your home’s purchase price.
Refinance Your Current Mortgage
Refinancing is also an option to get rid of PMI if your property has appreciated in value. It is also your only option to get rid of private mortgage insurance if you took out an FHA loan and don’t want to wait 11 years or the loan’s lifetime. Most people get FHA loans because they do not have high enough credit scores to obtain a conventional mortgage. While the barrier to entry is lower for FHA loans, you should consider refinancing it when you exceed 20% equity in your home. The consistent payments on the FHA loan will also put your credit score in a better position.
Improve Your Credit Score
Your credit score is a critical number lender will review before providing you with financing. Raising your score before purchasing a house can help you qualify for a conventional mortgage. You can increase your credit score with a good payment history, a low credit utilization ratio, a healthy credit mix, a good credit age, and avoiding too many hard inquiries.
If you already have a home, raising your credit score can still help, especially if you have an FHA loan. You must have a 620 credit score or higher to refinance your FHA mortgage loan into a conventional mortgage loan. A higher credit score can help you secure a lower interest rate if you refinance a conventional mortgage. The lower interest rate makes it easier to gain equity in your home instead of allocating more of your payments to interest.
How to Get Rid of PMI Sooner
You can get rid of PMI when the loan-to-value (LTV) ratio falls below 80%. Homeowners should prioritize reaching 20% equity in their homes. When you get to 20% equity in your FHA mortgage, you should look into a refinance. The primary objective for both scenarios is obtaining 20% equity in your home. Implementing the following strategies will help you avoid insurance.
Pay A Little Extra Each Month
You don’t have to stop at one mortgage payment per month. Making an additional payment will trim your mortgage balance and get you closer to 20% equity in your home. Finding an extra $50 per month can go a long way. You will have to pay the mortgage off anyway, and speeding it up also gets you closer to a debt-free lifestyle. The monthly PMI payment represents funds that could have gone to your mortgage balance. A few extra upfront payments get you closer to turning insurance premiums into additional equity for your home.
Get a Second Mortgage
A second mortgage is a backdoor strategy that lets you avoid private mortgage insurance even if you cannot make a 20% down payment. Lenders look at the LTV ratio of your first mortgage to determine if you need private mortgage insurance.
If you make a $100,000 down payment on a $500,000 home, you will not have PMI tacked onto your conventional mortgage. You can reach the $100,000 by putting $50,000 down and taking out a second mortgage to put down the remaining $50,000. You end up with two monthly mortgage payments, and the second mortgage will have a higher interest rate. However, you get to escape private mortgage insurance payments. PMI payments do not reduce your mortgage balance, but the second mortgage payment will help you build your equity position.
Use a VA Loan If You Qualify
VA loans help current and former veterans get better financing for their homes. Borrowers who qualify for these loans can make 0% down payments and have no PMI on their loans. In addition, you only need to pay a one-time funding fee if you do not put any money down. You can also roll this expense into your principal balance during the closing, so you do not have to pay it upon purchasing your home.
