Private mortgage insurance (PMI) is sometimes required for borrowers who put less than 20% down on their home purchase. It can be paid for by the buyer with monthly premiums, a lump sum at closing, a combination of the two, or by the lender in exchange for a higher loan interest rate. This insurance protects the lender if the purchaser stops paying the mortgage. It does not provide the buyer with any protection. PMI can cost between .5% to 1% of the loan’s value. For a mortgage of $100,000 that could mean paying an extra $500 to $1,000 each year. This is an expense you want to eliminate as soon as you can.
Because lenders view 20% equity in a home as an indicator that they will recoup their investment, buyers who can provide more than a 20% deposit do not have to purchase PMI. If you were required to purchase PMI, you usually must keep it for at least two years. After that period, in most circumstances, you can cancel PMI once you have more than 20% equity in your home. Under the Homeowners Protection Act, lenders must automatically cancel PMI once the amount owed is 78% of the original mortgage and you are current in your payments. You can request cancellation a bit earlier, once your mortgage balance is at 80% of the original loan. Be aware that lenders will check your payment history and whether you have taken a second mortgage or a home equity loan which would influence the total amount owed on the property.
Other factors that influence how long borrowers must have PMI include the loan-to-value ratio (LTV), a calculation of the difference between the remaining mortgage amount and the property value. For example, someone buying a $100,000 house with a $10,000 down payment would be financing $90,000 or 90% of the home’s value. The LTV is 90%. LTV decreases as you make mortgage payments, but can also decrease because the property has become more valuable. Sometimes this happens because of factors you do not control, such as the average home prices in the neighborhood increasing. It can also decrease because you have taken steps to make your home more valuable. These steps could include improvements for energy efficiency, remodeling, or expansion.
If your home is more valuable than it was when you purchased it, your LTV has decreased. Considering the example above, if the purchaser adds a new kitchen immediately and the house is appraised at $112,000, the LTV ratio has decreased from 90% to 80.3% before the owners have paid down their $90,000 mortgage. If you change your LTV in this way and are current in your payments, you may want to ask for early cancellation of your PMI. You will need to get a new appraisal as proof that your home has become more valuable.
You might have to keep PMI for longer than you planned if your home has lost value leading you to lose equity. For example, someone providing a $10,000 deposit on a $100,000 home owes $90,000 or 90% of the home’s value and initially has 10% equity. If the home’s value dips to $90,000, that loan becomes 100% of the home’s value. The buyer no longer has equity and must maintain PMI until reaching 80% equity. If this happens to you, contact your lender to see if you are eligible for loan modification.