Tell The Bank This To Cut All Future Mortgage Payments
Purchasing a home with low or no down payment may sound attractive. However, in most cases it means agreeing to pay for mortgage insurance, which is financial protection for lenders if you default.
Mortgage insurance is one of many upfront and ongoing costs of purchasing a home with low down payment. In certain circumstances, mortgage insurance can be avoided or removed. In this article, we offer guidance about private mortgage insurance and how to deal with it.
What is private mortgage insurance?
Private mortgage insurance, or PMI, is an insurance policy paid by borrowers when taking out a mortgage loan. Unlike traditional insurance, which protects policyholders against losses, private mortgage insurance policies protect lenders instead. It is meant as a way to reduce risk and potential losses when borrowers default on their mortgages.
Not all mortgage loans come with private mortgage insurance. In general, borrowers who provide close to 20 percent of the home’s value as down payment are not required to carry private mortgage insurance. However, borrowers who provide less than 10 percent as down payment, or who are approved for some government-sponsored mortgage programs, are often required to do so. This is because most private mortgage insurance policies expire once the remaining principal balance falls below 80 percent of the original appraised value, or current market value, of the property.
The cost of a private mortgage insurance policy will depend on the size and type of home loan, down payment, financial history and credit score. On average, borrowers can pay an additional 0.3 to 1.5 percent of the loan amount as mortgage insurance. For example, someone with a credit score above 580, putting 3.5 percent as down payment to purchase a home through an FHA mortgage loan may be required to contract a 1.25 percent private mortgage insurance. However, if they provide 10 percent down payment, their mortgage insurance rate could be 0.3 percent instead.
Can private mortgage insurance be cancelled?
A private mortgage insurance policy does not last forever. Its purpose is to offset the additional risk of approving a mortgage loan with less than 20 percent down payment. As a result, they usually expire once homeowners make enough monthly payments to reach 20 percent equity on their properties.
For example, a family who put 10 percent down payment to purchase a $100,000 home starts with $10,000 in equity. To cancel their private mortgage insurance, they would need to make enough monthly payments to reach $20,000 in equity. However, that is not the only way of cancelling private mortgage insurance.
A homeowner can often cancel their private mortgage insurance if the value of their property falls below the originally appraised value. However, their equity must represent at least 20 percent of the home’s new market value to do so. Using the example above, six and a half years would be required to reach 20 percent equity if the house was purchased through a 30-year mortgage loan with a fixed interest rate of about 5 percent. However, if after five years the property’s value falls to $75,000, the owner would be able to cancel the private mortgage insurance ahead of time.
Having 20 percent equity is the most important step to cancel a private mortgage insurance policy. However, lenders also consider delinquencies and other active liens on the property. If someone meets equity requirements but has a history of late payments, their cancellation request may be denied. The same often happens if they have a second mortgage.
Mortgage insurance and government-backed loans
Home loans backed by the U.S. government follow unique rules with regards to mortgage insurance. Affected by special rules are loans guaranteed by the Federal Housing Administration (FHA), U.S. Department of Agriculture (USDA), and Department of Veteran Affairs (VA). These rules are in place to make sure these loans are affordable for all income groups, including single mothers.
Mortgage loans backed by the Federal Housing Administration require both upfront and annual mortgage insurance. This rule applies regardless of down payment. As of 2018, the upfront fee is 1.75 percent of the loan amount, and annual mortgage insurance rates range from 0.45 to 1.05 percent. The final rate will depend on factors such as loan term and amount.
Mortgage insurance cannot be cancelled for loans backed by the Federal Housing Administration. Prior to 2013, FHA loans operated under the same rules as other commercial mortgages. However, since that year, all FHA loans come with mortgage insurance policies that last for at least 11 years, and in some cases, for the entire loan term.
Loans backed by the U.S. Department of Agriculture also have both upfront and annual mortgage insurance fees. The upfront guarantee fee equals one percent of the loan amount, while the annual mortgage insurance equals 0.35 percent. The upfront payment, often referred to as the USDA funding fee, is paid along all other closing costs. The annual fee cannot be cancelled and is paid for the entire loan term.
VA loans do not require mortgage insurance. Instead, they have an upfront funding fee that replaces both down payment and mortgage insurance. The fee varies depending on loan amount and nature of military service. In general, it ranges from 1.25 to 3.3 percent of the total loan amount, and is paid along with all other closing costs.
Avoiding private mortgage insurance
Private mortgage insurance gives families access to financing they would otherwise not have. It also gives lenders more flexibility when setting up down payment requirements. However, paying mortgage insurance can become a significant burden, as it increases monthly payments. In some cases, families can pay as much as $150 each month in mortgage insurance, which adds up to thousands of dollars.
Purchasing a home is more than just asking for a mortgage loan. Most families also have to deal with homeowners association fees, property taxes, home warranties and home insurance. When those additional costs are factored in, monthly house-related expenses can add up to a thousand dollars or more.
Avoiding private mortgage insurance is one way of reducing monthly bills. Although it might require putting down a larger down payment, doing so has additional benefits, such as lower interest rates, closing costs and monthly payments. Lenders often give homebuyers with good financial histories more flexible terms, which may include no private mortgage insurance in exchange for a small increase in down payment.
Getting rid of private mortgage insurance
Mortgage insurance is often one of the first expenses families want to get rid of once they start paying back their home loan. Cancelling a private mortgage insurance policy can be achieved in several ways.
The first and most straightforward way of getting rid of private mortgage insurance is waiting for automatic cancellation. Most lenders are required to cancel mortgage insurance when a mortgage reaches a 78 percent loan-to-value ratio or when homeowners have made half of all monthly payments.
The first condition was set by the Homeowners Protection Act of 1998, which established 78 percent loan-to-value ratio as the point where private mortgage insurance is no longer needed. To calculate the loan to value ratio of a mortgage, homeowners must divide the remaining loan balance by the original purchase price. For example, a family who purchased a $100,000 home will reach 78 percent LTV once the remaining balance falls below $78,000. This may take four to six years because most lenders front load interest in early mortgage payments.
The second condition is when homeowners have made half of the total amount of monthly payments. For example, a family who purchased a home through a 30-year mortgage loan will reach the halfway point after 15 years or 180 monthly payments. Once they reach the halfway point, lenders are required to cancel mortgage insurance regardless of loan-to-value ratio.
The second way of removing private mortgage insurance is by requesting early cancellation. This option becomes available once the remaining mortgage balance is 80 percent of the original purchase price. If this is the case, homeowners can submit a cancellation request that must be addressed by lenders. It often takes up to six years to reach 20 percent equity due to front-loaded interest in mortgage payments. However, families can speed up the process by paying more each month or performing a new appraisal of the property.
Homeowners must meet certain requirements in order to request early cancellation. Most lenders would like to see a good payment history, no other liens on the property such as a second mortgage or home equity line of credit, and proof of value, which is often an appraisal or broker assessment. The proof of value must be paid by homeowners and can cost up to $500.
The third way of removing private mortgage insurance is by boosting property value through home improvements. This method is also useful when home prices are rising in the area. This is because higher property values can push loan-to-value ratio at or below 78 percent, triggering mortgage insurance cancellation. Refinancing the mortgage is also a way of getting rid of private mortgage insurance. However, families should make sure refinancing costs are not higher than the mortgage insurance payments they are trying to avoid.