How to Remove Private Mortgage Insurance (PMI)?
What You Should Now
- Private Mortgage Insurance (PMI) is required for conventional loans when a borrower contributes less than 20% for a down payment.
- Private mortgage insurance may have a yearly fee that ranges from 0.1% to 2% of the outstanding principal.
- The premium charged on private mortgage insurance is determined based on the risk factors associated with the borrower.
- A borrower has many options to avoid PMI or get rid of it once it is already set up, but they should have enough funds to ensure that it is possible.
What Is Private Mortgage Insurance?
Private mortgage insurance, also known as PMI, protects a lender of a conventional mortgage in case a borrower defaults on their loan. Even though this insurance protects the lender, the borrower pays the mortgage insurance premiums (MIP). Private mortgage insurance is usually applicable to conventional loans because other mortgage types have other mortgage insurance premiums.
Lenders usually require private mortgage insurance when a borrower contributes less than 20% as a down payment. More precisely, lenders require private mortgage insurance any time the borrower has a Loan-to-Value (LTV) Ratio of more than 80%. LTV ratio measures how much money a borrower owes on their property compared to the total value of the property. If a borrower puts 20% as a down payment, then their LTV is 80%, which allows the borrower to avoid private mortgage insurance. It is also important to understand that if a borrower pays a 20% down payment, but then their house decreases in value significantly, their LTV ratio can go above 80% and even above 100% in some extreme cases. In these cases, the lender may require the borrower to get private mortgage insurance while the LTV ratio is above 80%.
How Much Does PMI Cost?
Usually, private mortgage insurance costs from 0.5% to 1.5% of the loan amount annually. In some extreme cases, PMI can go as low as 0.1% and as high as 2%.
Even though mortgage insurance does not benefit a borrower, some borrowers may be better off contributing a smaller down payment and paying for private mortgage insurance. Some areas see a significant and consistent growth in housing prices over time, which makes them prohibitively expensive for some people to purchase them. Some people may still be able to afford it, but they may not have enough to cover a 20% down payment. In that case, private mortgage insurance may be useful even though it means that the borrower will have to pay extra for it. Private mortgage insurance may be useful for borrowers who are looking to buy a property but may not have enough money to cover the down payment. A borrower should also be aware that there are ways to cancel PMI early, which may lead to large savings down the road. It is important to understand what lenders look at when determining whether to require PMI or not.
How To Get Rid Of PMI
There are many different ways to avoid PMI at the time of loan origination. On the other hand, it is not always possible to avoid PMI completely. People who must get PMI and would like to stop paying for it as soon as possible may find it useful to understand how they could get rid of PMI once they already have it. If there are reasons that may make a case for why insurance is not needed anymore, the borrower should contact their insurance provider and discuss available options. In addition, PMI can be deducted from income tax in some cases.
Depending on the type of private mortgage insurance, the steps for getting rid of it may differ. As a rule of thumb, private mortgage insurance can be canceled once a required LTV ratio is reached. Usually, PMI can be canceled once the LTV of 80% is reached, which is also equivalent to putting a 20% down payment. A 20% down payment is required for a mortgage without PMI. This means that any changes to the value of the property as well as the outstanding loan balance may help a borrower to get rid of PMI faster. The most popular ways that help a borrower cancel PMI faster include the following:
Trigger Automatic PMI Cancellation
One of the most straightforward ways to get rid of PMI is to wait until the borrower builds enough equity in the house for PMI to cancel automatically. The Homeowners Protection Act outlines the conditions that must be met for private mortgage insurance to be canceled automatically. The following conditions must be met for a borrower to get an automatic cancellation of private mortgage insurance:
- A borrower will get automatic PMI cancellation on the date on which the principal balance of the mortgage is first scheduled to reach 78% of the original value of the property securing the loan (LTV).
- The borrower must be current on mortgage payments. If the borrower is not current on mortgage payments, PMI can be canceled on the month the borrower is current on their payments.
A borrower should not worry about paying for PMI throughout their loan because there is legislation that protects the borrowers in case they cannot cancel PMI on their own. As a rule of thumb, the PMI will cancel once the LTV ratio of the loan lowers below 78%. It is important to remember that the PMI will cancel automatically only if the borrower is current on their mortgage payments. If the borrower is late on their payments, they will have to cover all overdue payments before private mortgage insurance can be canceled.
It is also important to note that an insurer must terminate PMI at the midpoint of the loan regardless of the LTV of the loan. For example, PMI will be terminated automatically on year 10 for a 20-year mortgage, and it will be terminated on year 15 for a 30-year mortgage. This applies to all conventional mortgages regardless of their LTV at the time of final PMI termination.
Request PMI Cancellation
There are procedures set in place that protect borrowers against paying for private mortgage insurance when they are not required to. On the other hand, the triggers that cancel PMI automatically may not represent the best interest of borrowers. For example, PMI is usually canceled automatically once the LTV ratio of the loan lowers below 78% while most lenders of conventional loans do not require private mortgage insurance once the LTV ratio of the loan lowers below 80%. This means that a borrower can cancel their PMI earlier and potentially save thousands of dollars by canceling PMI manually.
It is also important to note that automatic PMI cancellation is triggered based on the original mortgage amortization schedule. This means that if the borrower chooses to pay extra every month to pay off the mortgage earlier, automatic cancellation may still take place on the date specified in the original closing disclosure. If a borrower expects to pay off their loan ahead of the original schedule, they should closely monitor the LTV ratio or their loan. Once it reaches 80%, the borrower should contact their lender or private mortgage insurance company to discuss the cancellation of PMI.
If a borrower chooses to cancel their PMI manually, they would have to ensure to complete the following steps:
- Stay Current on Mortgage Payments With Good Payment History.
- Meet Other Lender Requirements (e.g. No Second Mortgage).
- Conduct a Home Appraisal If Required.
- Request PMI Cancellation in Writing from the Lender or Insurer.
Example: Canceling PMI vs Waiting for Automatic Cancellation
Suppose, a borrower wants to buy a property for $500,000. After closing costs. The borrower puts a down payment of 10% or $50,000, and the borrower takes out a loan for $450,000 for 20 years with a mortgage rate of 5%. Since their down payment is less than 20%, the borrower has to take private mortgage insurance that has a 1% annual fee.
After some time, the borrower gets to an LTV ratio of 80%, and they are wondering whether they should cancel their PMI right now or should they wait until it is canceled automatically at an LTV of 78%. The borrower understands that they would have to pay more, but they would like to know how much more exactly they would have to pay. Looking at the Closing Disclosure, the borrower finds the following information.
| A Snippet of a Mortgage Amortization Schedule | |||||
|---|---|---|---|---|---|
| LTV Ratio | Month | Beginning Balance | Monthly Payment | Ending Balance | PMI Premium |
| 79.97% | Month 43 | $399,863.41 | -$2,969.80 | $398,559.71 | $339.64 |
| 79.71% | Month 44 | $398,559.71 | -$2,969.80 | $397,250.58 | $339.64 |
| 79.45% | Month 45 | $397,250.58 | -$2,969.80 | $395,935.99 | $339.64 |
| 79.19% | Month 46 | $395,935.99 | -$2,969.80 | $394,615.92 | $339.64 |
| 78.92% | Month 47 | $394,615.92 | -$2,969.80 | $393,290.35 | $339.64 |
| 78.66 | Month 48 | $393,290.35 | -$2,969.80 | $391,959.26 | $339.64 |
| 78.39% | Month 49 | $391,959.26 | -$2,969.80 | $390,622.62 | $326.63 |
| 78.12% | Month 50 | $390,622.62 | -$2,969.80 | $389,280.42 | $326.63 |
| 77.86% | Month 51 | $389,280.42 | -$2,969.80 | $387,932.62 | $0 |
After estimating Private Mortgage Insurance premium, the borrower finds out that they would be able to save over $2,500 over the course of 9 months. The borrower finds the savings significant enough to cancel PMI manually.
Build Sweat Equity to Cancel PMI
Building sweat equity is a less conventional but still very popular way of getting rid of PMI faster. Sweat equity refers to the equity that a homeowner can get by improving their property. When a homeowner improves their property, they increase the value of the property while the loan amount stays the same. Since the outstanding principal does not change while the value of the property increases, the loan-to-value ratio may decrease, which may lead to PMI cancellation.
Sweat equity may help a borrower to get to 20% in equity to get rid of PMI. It is important to note that if a conforming loan is owned by Fannie Mae, the borrower must reach an LTV ratio of less than 75% to cancel PMI using sweat equity. Once the homeowner finishes working on the house improvements, they will have to conduct a home appraisal to determine the new value of the property.
Even though home improvements usually lead to a higher home value, the improvements may not be enough to lower the LTV ratio below 80%. A homeowner should also consider the amount of money spent on the improvements. In some cases, it may be more beneficial to contribute funds towards an outstanding principal rather than improvements to the property. As a rule of thumb, if the property has been recently renovated, then sweat equity may not lead to considerable benefits. Sweat equity should be applied to older, fixer-upper properties that have more potential to increase in value once improved.
Reappraise the Property to Cancel PMI
Sometimes a property may increase in value rapidly due to market trends. Even though the property does not change, the change in the value of the property may affect the LTV ratio drastically. This means that the LTV may actually drop enough for the lender to allow the borrower to cancel PMI.
There are rules implemented for this type of cancellation that protects the lender from volatile real estate markets. The private mortgage insurance cannot be canceled due to an increase in property value for the first 2 years. On the other hand, a homeowner may request to cancel private mortgage insurance once they reach 25% in equity if the request is made 2 – 5 years after the loan is originated. After 5 years, the homeowner can cancel private mortgage insurance once they reach 20% in equity.
For the request to cancel private mortgage insurance to be completed, the borrower must be current on your mortgage payments, and an appraisal must be done to estimate the value of the property. If a borrower does not request a private mortgage insurance cancellation, it will be automatically canceled when the LTV lowers to 78% according to the original mortgage amortization schedule. If the borrower is planning to deviate from the schedule, they should notify the insurance company to avoid overpaying for PMI.
Refinance Mortgage to Cancel PMI
Another way to cancel PMI is to refinance the current mortgage. Refinancing is the most flexible way to cancel PMI, but it also comes with refinance closing costs that may be quite expensive in some cases. The main advantage of refinancing a mortgage is that a borrower can skip the requirements that are imposed on PMI. For example, if a borrower recently bought a property with PMI, and the property has risen in value, the borrower may not be able to cancel PMI in the first two years. On the other hand, they can refinance their mortgage, and get a new mortgage without PMI if the new loan-to-value ratio permits.
It is important to note that even though it is a good strategy for the properties that have increased in value dramatically, it may not fit the borrowers that did not experience a large increase in the value of their property. Some homeowners may experience a decline in their home prices, which may lead to even higher mortgage insurance premiums. A borrower who is looking into refinancing their loan to get rid of PMI should work closely with a lender to see whether it makes financial sense to refinance their loan.
How to Avoid PMI
If a borrower is still looking to get a mortgage, they can also look into ways to avoid private mortgage insurance completely. Generally, there is no single way to avoid PMI that would work for everyone. A borrower should also be realistic about their abilities to get a mortgage without private mortgage insurance. For example, if a borrower has only 5% for a down payment and is not eligible for government loans, it is likely that they will have to pay for private mortgage insurance. On the other hand, there are programs and strategies to consider to minimize or fully avoid PMI expenses over time.
Make a 20% Down Payment
The most straightforward way to avoid private mortgage insurance is to contribute a down payment of 20% at the time of loan origination. Even if a borrower cannot put down 20% at once, they can request to cancel borrower-paid mortgage insurance once their LTV ratio drops below 80%. Once the borrower’s LTV ratio reaches 78%, the PMI is usually removed automatically.
| Minimum Down Payment Requirements for Conventional Loans by Home Price | ||||||||
|---|---|---|---|---|---|---|---|---|
| Home Price | $300,000 | $400,000 | $500,000 | $750,000 | $800,000 | $900,000 | $1,000,000 | $1,500,000 |
| Minimum Down Payment | $9,000 | $12,000 | $15,000 | $22,500 | $24,000 | $27,000 | $30,000 | $45,000 |
| Down Payment To Avoid PMI | $60,000 | $80,000 | $100,000 | $150,000 | $160,000 | $180,000 | $200,000 | $300,000 |
| Minimum Down Payment Requirements for Conventional Loans by Home Price | ||
|---|---|---|
| Home Price | Minimum Down Payment | Down Payment To Avoid PMI |
| $300,000 | $9,000 | $60,000 |
| $400,000 | $12,000 | $80,000 |
| $500,000 | $15,000 | $100,000 |
| $750,000 | $22,500 | $150,000 |
| $800,000 | $24,000 | $160,000 |
| $900,000 | $27,000 | $180,000 |
| $1,000,000 | $30,000 | $200,000 |
| $1,500,000 | $45,000 | $300,000 |
Consider Government Loans
While it’s possible to avoid PMI by taking out a different type of loan, some government-backed loans such as FHA loans and USDA loans have their own mortgage insurance fees that must be paid by the borrowers. Even though they have these fees, they are usually cheaper than private mortgage insurance for conventional loans. For example, FHA MIP is usually cheaper than conventional PMI, and it has clear rates that can be found using the FHA MIP Calculator. In addition, USDA Mortgage Insurance has some of the lowest rates among all other mortgage insurance types.
Out of all government-backed loans, the VA loan is the one that does not require periodic mortgage insurance payments. Instead, VA loans have a one-time funding fee that’s either paid at closing or rolled into the loan principal. The VA funding fee may also be referred to as VA loan mortgage insurance. The size of the funding fee varies according to the amount of your down payment or loan-to-value ratio. The funding fee can range from 1.4 – 3.6% of the loan amount. You can use this VA Funding Fee Calculator to estimate your mortgage insurance on a VA loan. On the other hand, if a borrower receives a VA Streamline Loan, their funding fee will always be 0.5%. It is also important to note that eligible borrowers who have a disability or are qualified surviving spouses of someone who was killed in action or passed as a result of a service-connected disability may not need to pay the funding fee.
Look Into First-Time Home Buyer Programs
There are numerous first-time home buyer programs offered on a federal level as well as state and even municipal levels of government. Different levels of government often offer different programs that provide certain financial assistance to first-time home buyers. This assistance can be offered in the form of a forgivable loan, a grant, down payment assistance, or even a modified mortgage loan with unique features.
A borrower who is looking to purchase their first home and make it their primary residence should definitely consider first-time home buyer programs. These programs may be useful for people who may not have enough funds to cover a 20% down payment by providing extra money that can be spent on closing costs and down payment. It may take time to find these programs, but it is worth researching because it may lead to large savings down the road.
Consider A Piggyback Loan
Another option available for borrowers to avoid hefty PMI fees is a piggyback loan. A piggyback loan consists of the first mortgage loan and a second loan that adds on top of the first one. This allows a borrower to make a down payment of around 10% or more and cover the other 10% with the second mortgage, which could be in the form of a personal loan or even a Home Equity Line of Credit (HELOC). These funds will go towards the 20% down payment that is required to avoid PMI. Once the second loan is received, the borrower can get a mortgage without the PMI.
Although a HELOC can help avoid the need for PMI, a borrower still has to make interest payments on a second mortgage. In this case, the borrower drops PMI premiums, but they are required to pay interest on their loan. It is important to understand how much a borrower will have to pay on their second loan because in some cases, it is more beneficial to get a PMI rather than a piggyback loan.
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