Home buyers who put down less than 20% when they bought their home most likely pay for mortgage insurance (PMI for conventional loans; MIP for FHA loans). But with proper planning and some patience, you can dump your PMI payment and lower your housing payment.
Mortgage insurance protects your lender if you stop paying your mortgage. The mortgage insurance premium is part of your mortgage bill each month. How much your PMI payment is depending upon the size and type of loan, how much you put down, and your credit score.
For example, if you have a 700-credit score, make a 5% down payment and have a $200,000 loan, you will pay roughly $156 per month in PMI. Many homeowners do not know that they can get rid of PMI, either sooner or later.
How to Do It the Slow Way
If you are paying your home loan on time and according to the schedule you were given, mortgage insurance on conventional loans eventually will go away by itself. The lender is mandated by federal law to end your mortgage insurance when the loan balance reaches 78% of the original value of the home. But when that time comes, you must be current on the loan. If you have missed payments in the past year, this could delay the removal of PMI.
The problem with this method is that it takes years to get rid of PMI. Note that paying down the loan faster does not make this process go faster? Why? Because automatic ending of PMI at the 78% threshold is not based upon the payments you make. Rather, it is based upon the date your loan is scheduled to get to 78% according to the amortization schedule.
The federal law governing the canceling of PMI is called the Homeowner’s Protection Act of 1998. It only applies to home loans made on your primary residence.
Note that FHA loans are not controlled by the same law. MIP cannot be cancelled on loans that were issued after June 2013 if you put down less than 10%. If you put down 10% or more, you can cancel MIP after all years. That is an awfully long time to wait, especially when you consider you will probably have well above 20% equity in the property by then. Your best option when you reach 20% equity with an FHA loan is to refinance into a conventional loan. This means needing to have your credit score and debt to income ratios up to snuff, so you can qualify under conventional loan standards.
How to Do It the Faster Way
One option is to pay down the loan faster to 80% of the home’s original value when you bought it. Then you can ask the lender to cancel PMI. But the lender is not required to do so. This is different than having 20% equity in the property, based upon the current value on the market.
Experts stress that many people think they can get rid of PMI when they have 20% stake in the home, but this is not always true. Borrowers can ask the mortgage company to cancel PMI based upon the home’s present value. But the borrower may have to wait two or five years after getting the loan to make the request. The lender can reject your request for several reasons, depending upon the investors who own your home loan.
Lenders are more likely to green light a request that is based upon what the home was worth when you closed the loan. You also need to have a good payment history to get approved. This means you cannot have 30 day or more late payments in the last 12 months, or no 60-day late payments in the past 24 months.
Even if you meet all of the above requirements, the lender still may not allow you to cancel PMI. Some lenders will say that the home went down in value and the risk to the lender is too high. Having a second mortgage also can prevent the canceling of mortgage insurance.
The Easiest Way – Refinance
The fastest way to cancel mortgage insurance is to refinance the loan. You have to have a current appraisal on the home. If you can show that you clearly have 20% equity, you do not need mortgage insurance on the new loan.
Even if you do not have 20% equity but you do have cash to pay down on the loan, refinancing could be a more effective option than paying down your current loan. In the latter case, you still are relying on the lender approving your request to cancel PMI. With a refinance, if you show you have 20% equity, the lender cannot force you to have PMI. With a refi, you are in complete control.
References: How to Get Rid of Private Mortgage Insurance. (2013). Retrieved from http://www.foxbusiness.com/features/2013/02/06/how-to-get-rid-private-mortgage-insurance.html