There are several pros and cons of getting a mortgage with a low down payment, and one of the cons is often mortgage insurance. Whether you’re purchasing a new home or refinancing a current one, obtaining a home loan for more than 80% of a property’s value often comes with an added monthly cost for mortgage insurance. Thankfully, mortgage insurance doesn’t last the life of your loan, but you may need to take action to avoid paying more than necessary. Here’s what you need to know about getting rid of mortgage insurance.
What is mortgage insurance?
Mortgage insurance allows borrowers to obtain loans with smaller down payments or less equity while protecting lenders from the extra risk of extending these loans. Mortgages with less than 20% equity (i.e. with loan balances more than 80% of a property’s value) are considered extra risky to lenders, so mortgage insurance is often required in these cases. The insurance reimburses the lenders if the borrowers default on their mortgages, allowing the lenders to offer these loans.
Mortgage insurance on conventional (non-government) loans is provided by private companies and is known as private mortgage insurance (PMI). The mortgage insurance on government loans, such as Federal Housing Administration (FHA) loans, has different rules and is not addressed in this article.
Depending on a loan’s down payment percentage, the borrower’s credit score and the mortgage product, PMI typically costs about 0.19 to 1 percent of the loan amount annually. At 0.19 percent on a $200,000 loan, this would come out to $380 per year or $31.67 per month. At 1 percent on the same loan, that would be $2,000 per year or $166.67 per month. This cost is typically paid by the borrower and is known as “borrower-paid” mortgage insurance in those cases.
The Homeowners Protection Act of 1998 (the “PMI Cancelation Act”) went into effect on July 29, 1999 in response to homeowners who were having difficulty cancelling their PMI. The Act lays out three situations where borrower-paid PMI can be cancelled: automatic termination, borrower-requested cancelation and final termination.
Lenders are required by law to disclose at closing how long it will take to pay down a loan to cancel mortgage insurance. As lenders often sell mortgages to mortgage servicers, the servicers must provide a yearly statement that shows whom to contact about cancelling the insurance. (In the sections that follow, the word “lender” refers to the current servicer of the loan.)
In keeping with the Homeowners Protection Act, your lender is required to terminate your PMI on the date your loan balance is scheduled to reach 78% of the original value of your home (i.e. when your equity reaches 22%) so long as you are current on your mortgage payments. If you are behind on your mortgage payments on the date when the 78% threshold is scheduled to arrive, the lender must then cancel your PMI on the first day of the first month after you become current on your payments. Once your PMI has been canceled, your lender can’t require additional PMI payments more than 30 days after the cancellation date or – if you are behind on payments – the date after cancellation when you become current on your payments, whichever is sooner.
It’s important to note that the 78% threshold for automatic cancellation refers to the date that the loan is scheduled to reach 78% based on your amortization schedule. It is not based on your actual loan balance. Therefore, if you make extra payments on your mortgage and reach the 78% threshold ahead of schedule, your lender is not required to cancel your PMI until the originally scheduled date, which could mean you’ll continue making unnecessary PMI payments for months or even years. To avoid paying more than you need to, you can request cancelation of PMI coverage as described in the next section.
By law, borrowers with a good payment history can request that their PMI be canceled when their equity in the property reaches 20% (i.e. when their loan balances falls to 80%) of the purchase price or appraised value. A “good payment history” means you have:
- not been 60 days or more past due on a payment within the first 12 months of the last two years prior to the cancelation date (or the date when you request the cancelation, whichever is later); and
- not been 30 days or more past due on a payment within the 12 months prior to the cancelation date (or the date when you request the cancelation, whichever is later).
To request cancelation, you must fulfil the following criteria:
- Submit a written request for cancelation
- Have a good payment history
- Be current with your mortgage payments
- Satisfy lender requirements to show that the property’s value has not dropped below the original value (for example, by getting an appraisal, typically $300-500)
- Provide certification that your equity in the home is not subject to a subordinate lien, such as a second mortgage
Paying down your mortgage faster isn’t the only way to build enough equity to qualify for an early cancellation. Renovations or expansions to your home that add value also contribute to your equity, and if your home value increases due to a rise in the real estate market, that will boost your equity as well.
Even if you have not reached the 78% threshold, you may still be able to cancel your PMI. The law requires that your lender must terminate PMI by the first day of the month after the date when your loan reaches the midpoint of its amortization schedule. For example, the midpoint on a 30-year loan would be reached after 15 years.
You must be current with your payments for final termination to take effect. If you’re behind on your payments, your PMI will be terminated when you become current.
One last way of getting rid of PMI is refinancing into a new loan without it. If you can get a new loan with 20% equity, then you’ll be PMI free. Getting a new loan is an involved process that includes finance charges, however, so it’s important to crunch the numbers to see if you’ll come out ahead or not. Typically, if you can finance into a lower interest rate and lose your PMI, the move may be in your favor.
PMI is often a necessary cost of getting home financing without a large down payment, but if you know your rights and the rules, you can ensure that when the time comes, you never pay another unnecessary PMI payment again.