The higher housing prices rise, the more difficult it is for first-time home buyers to come up with enough cash for both closing costs and the 20% down-payment most lenders require. PMI solves this problem for many home buyers.
What Is PMI and How Is It Calculated?
It would take the average couple more than five years to save enough for a 20% down payment on even a modest home, but thanks to PMI, home buyers can purchase a home years earlier by buying insurance that protects the lender. Private Mortgage Insurance (PMI), protects your lender if you default on your loan. It’s calculated based on the amount you borrow for your house, and is rolled into your loan and added to your monthly payments. Remember: PMI protects the lender if you default on the loan; it does NOT protect you.
How Do I Know If I Still Need to Pay PMI?
Before the Homebuyers Protection Act was passed by Congress in 1998, lenders were not required to notify homeowners when the equity in their home reached a level where PMI was no longer required, so many homeowners continued to pay this cost unnecessarily for years.
Your home falls under this act if you purchased, constructed, or refinanced your single-family home after July 29, 1999, and your loan is not a government-insured FHA or VA loan. If you purchased your home before July 29, 1999, your lender is not required to cancel your PMI when you reach 20 or 22% equity, but many lenders will do so if you ask.
How and When Do I Cancel PMI?
If the act applies to you, your lender is required to automatically terminate your PMI when your equity reaches 22% of the original property value at the time you took out the loan.
For example, say you purchased a house valued at $100,000, paid $5,000 down, and financed $95,000. Your PMI would be cancelled when your equity reached $22,000, i.e., when the principal balance of your loan reached $78,000 (see calculation below).
Alternatively, rather than waiting for your lender to cancel the PMI, you can request that it be cancelled when your equity reaches 20% of the original value of your home (as long as it hasn’t decreased in value). If your mortgage is owned by Fannie Mae, PMI can also be cancelled when your loan balance goes down to 75 percent of your home’s current value, as established by a new appraisal. The loan has to be at least two years old and you must have made your mortgage payments on time.
Paying PMI for even one month longer than necessary is throwing away your money. Know what your principal balance has to be in order to cancel your PMI, and obtain an amortization schedule of your loan (a schedule which shows how much of each monthly payment goes to principal and how much to interest and what the balance is after each payment) so you can see clearly when you reach that point. Don’t wait for your lender to notify you that your PMI can be cancelled. It will cost you money as you wait for your equity to grow from 20% to 22%.
If you’re not sure whether you are paying PMI, call your lender or the company that services your mortgage. If they inform you that you are paying PMI, ask for the details on when and how it can be cancelled. Don’t pay a business to handle this for you–it’s straightforward enough to do yourself.
One important note: in order for these protections to apply to you, your mortgage payments must have been current for at least the last year, you cannot have any liens on your property, and your loan cannot be considered “high risk.”
How Much Does PMI Cost?
On a $100,000 loan with a $5,000 down payment, PMI might cost you between $40 and $45 a month, or $480 a year. The cost on larger mortgages can be much greater. Cancelling as soon as possible can save you many thousands of dollars over the life of the loan.
Calculation: $100,000 value of the property at purchase or refinance times 78% (100% minus 22% equity required) = $78,000 loan balance or lower required before PMI will automatically be cancelled.
