Homebuyers with a down payment of less than 20 percent are usually required to get private mortgage insurance, or PMI. This is an added annual cost — about .03 to 1.5 percent of your mortgage.
How much you pay in PMI depends on your credit score and the amount of your down payment. PMI can tack on hundreds of dollars to your monthly housing bill. The bright side is that there are ways you can get rid of it.
“Private mortgage insurance protects the lender from the elevated risk presented by a borrower that made a small down payment,” says Greg McBride, CFA, Bankrate’s chief financial analyst. “Once the borrower has a sufficient equity cushion, the PMI will be removed.”
How to get rid of PMI
There are options for homeowners eager to save money each month by losing those costly PMI payments — or even avoiding them altogether (even without making a 20-percent down payment). Here are a few of them.
Pay down your mortgage balance
For folks with PMI, you must have at least 20 percent equity in the home to eliminate it. You may ask the lender to cancel PMI when you have paid down the mortgage balance to 80 percent of the home’s original appraised value. When the balance drops to 78 percent, the mortgage servicer is required to drop the PMI.
Calculating how much you need to pay down is straightforward. Simply multiply the purchase price of your home by 80 percent. For example, if the purchase price was $300,000, then you would multiply .80 by 300,000. The result is $240,000 — which is the minimum your loan balance needs to be before you can get rid of the PMI.
You can prepay the principal on your loan, reducing the balance, which helps you build equity faster and save on interest payments. Even $50 a month can mean a dramatic drop in your loan balance over time.
Some people choose to apply a lump sum toward their principal or even make an extra mortgage payment per year. That will get you to the 20 percent equity level faster.
Refinance your mortgage to get out of PMI
When mortgage rates are low, as they are now, refinancing can help you to not only get rid of PMI, but reduce your monthly interest payments. It’s a double dose of savings.
The refinancing tactic works if your home has gained substantial value since the last time you got a mortgage. For example, if you bought your house four years ago with a 10 percent down payment, and the home’s value has risen 15 percent since then, you now owe less than 80 percent of what the home is worth. Under these circumstances, you can refinance into a new loan without having to pay for PMI.
Many loans have a “seasoning requirement” that requires you to wait at least two years before you can refinance to get rid of PMI. So if your loan is less than two years old, you can ask for a PMI-canceling refi, but you’re not guaranteed to get approval.
Reappraise your home if it’s gained value
Folks who live in red-hot housing markets might have seen their home values shoot up in the last couple years. In fact, the value might have increased enough to bump you out of the PMI range. If this is the case, it’s time to talk with your lender about getting a new appraisal and potentially cancelling your PMI requirement. Appraisals can cost between $450 and $600, depending on your metro area.
Remodel or renovate your house to boost value
If you plan to add amenities to or renovate your home, you might increase the value which could mean more equity. If you cross the 20 percent equity finish line in the process, then you can kick PMI to the curb.
Whether it’s an extra room or a pool, common upgrades like these can increase your home’s market value. Ask the lender to recalculate your loan-to-value ratio using the new value figure.
Although you can cancel private mortgage insurance, you cannot cancel Federal Housing Administration insurance. The only way to get rid of FHA insurance is by refinancing into a non-FHA insured loan.
Even without 20 percent down, there are mortgages that don’t require PMI
Not all home loans with sub-20 percent down payments call for PMI. This is one good reason why it pays to shop around for a mortgage.
Bank of America, for instance, has a loan called the Affordable Home Solution Mortgage that allow down payments as low as 3 percent and there’s no PMI requirement.
Flagstar offers the Professional Loan, which is an adjustable rate mortgage designed for people with a high earning potential. Borrowers can have low down payments and aren’t required to get mortgage insurance.
Don’t drain your bank accounts to escape PMI
While paying PMI each month — or as a lump sum each year — is no financial joyride, homeowners should be careful not to make their finances worse by hustling to get rid of PMI.
Most financial experts agree that having some liquidity, in case of emergencies, is a smart financial move. So before you tap your savings or retirement funds in order to reach that 20 percent equity mark, be sure to speak with a financial adviser to make sure you’re on the right track.
“There seems to be a philosophical aversion to PMI on the part of many buyers that is misplaced,” McBride says. “As long as you’re not taking an FHA loan, you’re not married to the PMI. You can drop it once you achieve a 20 percent equity cushion, which may only be a few years away depending on home price appreciation. But do not feel the need to use every last nickel of cash to make a down payment that avoids PMI, only to leave yourself with little in the way of financial flexibility afterwards.”
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