April 5, 2021
If you’re like many first-time homebuyers, you encountered an unfamiliar term as you prepared to close your mortgage transaction: private mortgage insurance (PMI). This article provides basic answers to some of the common questions homeowners ask about PMI.
PMI is an insurance policy you pay for that protects your mortgage lender from financial loss if you stop making your mortgage payments. And depending on your credit score, your down payment, and several other factors, your lender may require you to have PMI coverage on your mortgage. Here’s how it works:
• If you stop paying your mortgage and your lender is forced to take possession of your property, the lender can usually recover most of your property's appraised value (about 80%) in a foreclosure auction. Your PMI policy then pays your lender the remaining value of the property.
• If you consistently pay your mortgage on time, it may be possible to have your PMI policy canceled. But you'll need to pay down your loan's principal balance until you achieve 20% equity in your home (based on its original appraised value). Read on for more information about canceling PMI.
No. Your PMI policy insures only your lender against loss; it does not make mortgage payments for you if you’re injured or unemployed. So don’t be confused: Some mortgage companies also sell “mortgage insurance,” which makes your mortgage payment for you if you can't pay due to job loss, sickness, or other causes—but that’s not PMI. A “mortgage insurance” policy protects you, but a PMI policy protects only your lender.
Too many homebuyers don’t realize how much PMI can increase their mortgage payments. Also, PMI requirements can vary depending on the size of your down payment, your credit score, the type of mortgage you have, and some other factors. For example, on most FHA/VA loans and some other “non-traditional” loans, PMI is required—and it can significantly increase your regular mortgage payment.
For a “traditional” mortgage loan from a bank or a reputable mortgage company, the cost of your annual PMI premium is calculated based on the total amount you borrow; it’s often between 0.5% (one-half percent) and 1.5% (one-and-a-half percent) of your loan amount. While some lenders allow you to pay PMI “upfront” when you close your mortgage transaction, most homeowners choose to “roll” their PMI costs into their mortgage payments and extend them over several years of their mortgage term.
But even if you spread your PMI costs over years and include them in your mortgage payments, PMI can still be a significant expense. For example: If you buy a $200,000 house and you put $20,000 down (10%), the amount of money you’re borrowing (the principal) is $180,000. If your PMI premium rate is 1% of the principal, your annual PMI policy costs $1,800 ($150 per month). That’s a real stretch for some homeowners!
The easiest way to reduce PMI costs is to put more money down when you buy a house. For example, a down payment of 15% could help reduce your PMI premium rate (compared with a down payment of 10%). And in many cases, if you make a 20% down payment, your lender will not require PMI at all.
Yes, it’s possible to cancel PMI—but based on the kind of loan you have, you must satisfy certain requirements:
If you have a “conventional,” single-family mortgage (not one from Fannie Mae, Freddie Mac, the FHA, or the VA) and your loan closed on or after July 29, 1999, government regulations allow your lender to cancel your PMI after you’ve paid your mortgage down to 80% of the property’s original appraised value--that is, the value of your house on the day it was appraised for your current mortgage; also called the loan-to-value (LTV) ratio. To cancel PMI, you must meet these criteria:
Remember the $200,000 house you bought with 10% down? You’ll need to make about 26 monthly payments to bring your LTV ratio down to 80%.
But what if you’re unable to get your PMI canceled when your LTV ratio hits 80%? Hang in there a bit longer, because your lender is required by law to automatically cancel your PMI policy when your LTV ratio reaches 78%—provided your home is your primary residence and your payments are current.
Fannie Mae/Freddie Mac loans
If your mortgage is underwritten by “Fannie” or “Freddie,” your cancellation options are about the same as those of a conventional mortgage. Fannie and Freddie also allow you to cancel PMI on second-home mortgages and even some mortgages on investment properties. However, some of the details around Fannie/Freddie PMI cancellation are rather complex. Please contact us to learn more about canceling PMI on your Fannie Mae or Freddie Mac loan.
The rules are very different if you have an FHA/VA (Federal Housing Administration/Veterans Affairs) mortgage, which often requires no (or very little) money down. For example, if your LVT ratio is over 90%, the FHA will not cancel your PMI under any circumstances. But even if your LTV ratio is less than 90%, the FHA will not cancel your PMI for at least 11 years. There are other detailed requirements for canceling PMI on FHA/VA loans, so please contact us to discuss your options.
Yes—for now. PMI was originally deductible only through 2017. But in December 2019, Congress passed the Further Consolidated Appropriations Act 2020, which extended the PMI deduction through Dec. 31, 2020. Then in December 2020, the Consolidated Appropriations Act of 2021 was passed, which keeps the PMI deduction in effect through Dec. 31, 2021. See your tax preparer for details.
Yes. It’s possible to pay off your PMI sooner than you may have originally expected by using two strategies: Prepaying your mortgage principal and monitoring your home’s value:
Your mortgage principal balance is the amount you owe on your home—not including the interest your lender charges you. So if you pay extra against your principal, you’ll reach an 80% LTV ratio sooner, and you’ll be able to pay off your PMI sooner.
Monitoring home value
The other way you may be able to pay less PMI is to carefully monitor your home’s market value. In a strong housing market, it’s possible that your home may be worth a bit more every month you live in it. If you’re confident that your home’s value has significantly increased (beyond the principal payments you’ve made), talk with us and request a new valuation. Note: You’ll have to pay for the valuation, which could cost as much as $500. But if the new valuation reveals that your LTV ratio is 80% or less, you can ask us to cancel your PMI.
Depending on the kind of loan you have and the amount of equity you have in your home, canceling your PMI might be easy, not so easy, or impossible. The purpose of this brief article is to provide a basic understanding of PMI, but it’s not designed to cover every detail of every possible PMI scenario. If you still have questions, please contact us to get the specific answers you need for your unique situation.