If the down payment on your house was less than 20 percent, you’re probably paying Private Mortgage Insurance, or PMI. PMI helps to protect the lender if a home goes into foreclosure.
Based on 2014 stats from the National Association of Realtors Profile of Home Buyers and Sellers, the median down payment for first-time homebuyers was only 6 percent. If you’ve bought a house within the past few years, you may be one of the many homeowners paying Private Mortgage Insurance.
WHAT IS PMI, AND WHY ARE YOU PAYING IT?
The PMI on your mortgage could range from 0.3 to 1.5 percent of your loan per year. And whether or not you pay PMI all hinges on that 20-percent rule we mentioned. Dr. Bennie Waller, Department Chair and Professor of Finance and Real Estate at Longwood University, explains, “Private mortgage insurance allows homebuyers on non-government insured loans without the conventional 20 percent down to finance a home. Lenders typically lend on an 80 percent Loan to Value (LTV: i.e., Loan/Property value = 80 percent).”
Dr. Kimberly Goodwin, Parham Bridges Chair of Real Estate and Associate Professor of Finance at the University of Southern Mississippi, breaks PMI down further: “In simple terms, private mortgage insurance is an insurance policy for a mortgage lender in the event that a borrower can no longer make loan payments.”
A good example would be a buyer purchasing a $200,000 home with only $20,000 for a down payment. In this case, Dr. Waller says, “They would need to purchase PMI to cover the additional $20,000 to reach the required 20 percent down payment or the required $40,000.” Instead of putting extra cash in, a borrower pays a monthly payment to secure their premium.
This brings us to the bigger question — how to get rid of PMI. It comes back to the Loan to Value ratio Dr. Waller explained above. To get rid of PMI, the LTV on your mortgage needs to be at 80 percent. Your LTV may be lowered by either paying down your loan amount or seeing an increase in your property value.
A property value increase can be a big help in getting you to that 80 percent LTV faster. Dr. Goodwin urges homeowners who want to stop paying PMI to take advantage of increasing property value as soon as you are able. “Home price appreciation also creates equity for the owner, so getting a new property appraisal is important after a few years,” she says.
Dr. Waller notes that homeowners are generally required to pay for an appraisal in advance in case the property does not appraise for enough and PMI cannot be eliminated.
Our free LoanFly app gives you 24/7 access to your home loan. Click here to find out more.
4 TYPES OF PMI PAYMENTS (AND 4 WAYS TO GET RID OF IT)
Now we know that PMI is mandatory on conventional loans with a down payment of less than 20 percent. Josh Brown of Ark Law Group reminds us that PMI rates can depend not only on the size of a homebuyer’s down payment but on their credit score and the policies of a lender.
RATES CAN VARY, BUT BROWN SAYS YOU’LL TYPICALLY SEE FOUR DIFFERENT WAYS OF PAYING PMI:
1. Borrower-paid (BPMI) – “This is the default and therefore most common,” Brown explains. “Basically, it’s an additional monthly payment for a homebuyer that gets tacked on to the mortgage.”
2. Lender-paid (LPMI) – In this case, the lender pays the PMI. In return, the buyer gets a higher interest rate. “Typically, this is one-quarter to half a percentage point higher (but in some cases can be lower or higher). If a homebuyer is only looking to stay in a home short-term, such as 5 to 10 years, then this might be a better option. However, if this is a longer-term investment (more than 10 years), then PMI will most likely be the better option,” Brown says.
PMI gets dropped at the 20 percent threshold, while LPMI is never dropped because it’s bundled into the higher interest rate. LPMI does have the advantage of being tax-deductible since it’s all part of the mortgage payment. PMI as a separate monthly payment may not be tax-deductible, depending on who’s in Congress. In years past, Brown says, PMI has been tax-deductible but currently is not.
3. Single premium – The homebuyer makes a lump-sum payment at closing instead of making monthly payments.
4. Split premium – The homebuyer makes a partial upfront payment, and the rest gets paid on a monthly basis.
ONCE YOU UNDERSTAND THE INS AND OUTS OF PMI, IT DOESN’T SEEM SO COMPLICATED. YOU CAN TRY ONE OF OUR “NO MORE PMI” TIPS TO HELP REDUCE YOUR MONTHLY MORTGAGE PAYMENT:
1. Stay up to date. Pay monthly mortgage payments on time, and soon enough, you’ll reach that sweet spot where the principal balance of your mortgage falls to 80 percent of the original value of your home. Once that happens, you’re permitted by federal law to cancel your PMI. This cancellation request must be made in writing.
2. Refinance. If your home value has increased, your lender may no longer require PMI on your mortgage refinance.
3. Pre-pay when you can. An extra $50 to $100 a month could help to drop your principal balance over several years. Paying ahead can bring you that much closer to a “no more PMI” loan balance at 80 percent.
4. Wait it out. Time is on your side. Once your mortgage’s principal balance reaches 78 percent of your home’s original value, your lender must automatically terminate your PMI on that date.
The bottom line about PMI is this: If you have the funds for a 20 percent down payment, Brown recommends avoiding PMI when you can. Otherwise, consider the PMI you’re paying on a case-by-case basis. Right now, interest rates remain low. And if you’re buying in an area where home values are expected to increase, you may reach that 80 percent LTV even sooner.