If you are in the market to buy a new home and have less than a 20 percent down payment, you are usually required to buy private mortgage insurance.
Overview of PMI
Private mortgage insurance (PMI) is a mandatory mortgage insurance you have to pay when you take out a conventional loan. PMI protects the lender in the case you cannot make your mortgage payments.
The lender arranges the PMI, and private insurance companies provide coverage. It is usually required if you take out a conventional loan, but you have a less than 20 percent down payment of the purchase price of the home. It is also required if you are refinancing your house, but you do not have at least 20 percent equity in your home.
PMI typically costs between 0.5 percent and one percent of the full loan on an annual basis. Therefore, if your loan is $150,000, you could be paying as much as $1,500 a year (or $125 per month) in private mortgage insurance — presuming a one percent PMI rate.
There are several ways to get around PMI. Sometimes lenders will offer conventional loans that don't require PMI if you have a small down payment. With these loans, you may pay a higher interest rate, which can often be more expensive than the PMI itself. That depends on several factors, including how long you intend on living in the home. Not paying PMI and paying more in interest rates could affect your taxes, so it is a good idea to talk to your tax advisor before going this route.
Another option you have if you have a small down payment is taking out a different loan like an FHA loan. Loans like this could end up being more or less expensive than a PMI required conventional loan depending on your down payment, credit score, general market conditions, and lender.
The best way to avoid PMI is to save up your money until you can put 20 percent down on the house. PMI is not required if you pay the 20 percent down. Paying the 20 percent may also lower your interest rate.
Getting Rid of PMI
Once the principal balance of your loan drops to 80 percent of your home's original appraised value, you can ask to have the PMI canceled. Note that you will have to be current on your loan once the balance reaches 78 percent to get the PMI removed.
The steps you can to take to cancel your PMI sooner include:
- Refinance: To have PMI removed, you will need at least 20 percent equity in your home. If home prices in your area have been noticeably increasing, you will have built additional equity in your home. Refinancing with a better loan-to-value may put you past the 20 percent threshold.
- Have your home appraised again: To see if you now meet the 20 percent equity threshold, some lenders may allow for a new appraisal rather than going by the original sales price.
- Make prepayments on your loan: Even small payments a month added to your regular mortgage payment can help you get your loan balance down quicker.
- Remodel: Consider adding a pool or an additional room to increase the market value of your home. Then ask your lender to use the new value figure to recalculate your loan-to-value ratio.
When the market is experiencing near record low mortgage rates, refinancing will not just eliminate your PMI but will lower your interest payments each month as well.
You can still buy a home even if you do not have 20 percent down. Conduct research to learn more about how PMI works and when you will be able to get rid of yours.