If you put less than 20 percent down on your home, most mortgage lenders will require you to pay for private mortgage insurance, or PMI. The lower your down payment, the higher your probability of default. To compensate for the increased risk, lenders require PMI to approve the loan, ensuring they will be protected if you fail to make your payments.
Private mortgage insurance usually costs homeowners 0.5 to 1.0 percent of the loan amount annually, so if you require PMI to get approved for a $250,000 mortgage, expect to pay about $2,500 extra per year until or you can drop the insurance. Naturally, the sooner you can eliminate these extra fees, the better. Here’s how to get started.
What Exactly is Private Mortgage Insurance?
For those who don’t know, private mortgage insurance (PMI) is an insurance policy that helps protect the mortgage company by paying down the difference if you don’t make your payment on time.
Know Your Lender’s Rules
Generally, homeowners can request to drop private mortgage insurance when they have 20 percent equity in their property — and most lenders will cancel it automatically when their client reaches 22 percent equity. The time frame for reaching this threshold largely depends on the size of the down payment. A 15 percent down payment can accumulate 20 percent equity rather quickly, while 5 percent down can take several years.
But there is an additional caveat to this: different insurance providers, such as Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA), all have different rules. Some lenders, for example, require you to have PMI for four or five years before canceling. In the case of an FHA loan, PMI is required throughout the entire lifespan of the loan. Before you can sketch a plan to eliminate PMI, you must verify the parameters of your loan.
If waiting for your home equity to rise isn’t an option, the fastest way to eliminate private mortgage insurance is to refinance your mortgage. For those who have reached the 20 percent equity threshold but are still locked into PMI premiums for several years, this could save you thousands of dollars per year — if the lender fees and new interest rate don’t negate your savings.
When deciding to refinance, it’s imperative to shop around not just for the best interest rate, but also for the best fees. Many companies will even offer to pay certain fees for you, such as closing costs, appraisals, title insurance fees, etc. When meeting with a lender, ask for an itemized list of fees to give you a baseline for other lenders to match.
Moreover, interest rates are on the rise in the current housing market. If your new interest rate results in a net payment greater than your annual PMI premium, it might eliminate the purpose of refinancing in the first place.
Get an Appraisal
Even without a refinance, there are still ways to eliminate PMI sooner. For example, if you can prove to your lender that your equity has increased through market appreciation or a significant home improvement, that might be sufficient to get over the 20 percent threshold. To do this, you will require a professional home appraisal.
An appraisal can cost you between $300-$450 out of pocket. A free automated valuation model can also give you a ballpark estimate if you’re not confident enough to pay for a professional appraisal outright, but know going in that these estimates can be wildly inaccurate. Use them to verify your suspicions, but nothing more. If you want an accurate valuation of your home, you must hire a professional.
Know Your Numbers
Any move you make outside of waiting for your equity to grow will have an added cost, so do the math to determine if the numbers work out in your favor. Even a $300 appraisal would be difficult to justify if you will only be locked into your PMI premium for another month or two.