Private mortgage insurance (PMI) is required for mortgage loans where the buyer contributes less than 20% of the purchase price as downpayment. Lenders require PMI on most conventional mortgages because there’s a correlation between borrower equity and default.
The less money a borrower has invested in a home, the greater the probability of default. So, PMI is a financial guarantee that protects lenders against loss in the event that a borrower defaults. Without it, the 20% down payment that lenders typically require shuts many potential homebuyers out of the housing market.
PMI not only puts people in homes – it also allows them to buy the homes where they want to live. Consider that two out of five homebuyers who use PMI may not otherwise be able to buy a home, according to the Mortgage Insurance Companies of America, a mortgage industry trade group.
PMI also allows buyers to get more house. With $15,000 down, the most home you can buy while avoiding PMI is a $75,000 home. If you use the $15,000 to put 10% down with an insured loan, you can buy a $150,000 home. Of course, that assumes you’ve got the income to handle the mortgage payment.
Cost of PMI
But there is a cost. PMI certainly helps borrowers get into a home, but it’s darn expensive. Borrowers usually pay a half of one percent of the loan amount per year. On a $100,000 loan, that’s about $500 to $600 to ensure the top $20,000 of the loan you didn’t put down in cash.
And, lenders can charge PMI until you’ve reached 20% in equity. On a $100,000 loan with 10% down ($10,000), PMI might cost you $40 a month. If you can cancel it, you can save $480 a year and many thousands of dollars over the life of the loan. Check your annual escrow account statement or call your lender to find out exactly how much PMI is costing you each year.
With a 30-year fixed-rate loan, it could take up to 15 years to chisel it down until you have 20% equity, unless you’re paying extra on your loan every month. Homeowners can cancel PMI when there’s 20% equity in the home, based on the original property value and provided your mortgage payments are current.
How to get rid of your PMI
The good news is that the Homeowners Protection Act of 1998 (which became effective in 1999) established rules for automatic termination and borrower cancellation of PMI on home mortgages. According to the Federal Trade Commission, these protections apply to certain home mortgages signed on or after July 29, 1999 for the purchase, initial construction, or refinance of a single-family home. (Note: These protections do not apply to government-insured FHA or VA loans or to loans where the lender is paying PMI.)
For home mortgages signed on or after July 29, 1999, your PMI must be terminated automatically when you reach 22% equity in your home based on the original property value, if your mortgage payments are current.
If you signed your mortgage before July 29, 1999, you can ask to have the PMI canceled once you exceed 20% equity in your home. But federal law does not require your lender or mortgage servicer to cancel the insurance, so it’s important to stay on top of it. Here are other points covered by the law:
• New borrowers must be told – at closing and once a year – about PMI termination and cancellation.
• Mortgage servicers must provide a telephone number for all their mortgage borrowers to call for information about termination and cancellation of PMI.
• Even though the law’s termination and cancellation rights do not cover loans that were signed before July 29, 1999, or loans with lender-paid PMI, lenders or mortgage servicers must tell borrowers about the termination or cancellation rights they may otherwise have under those loans (such as rights established by the contract or state law).