Sometimes when you buy a house with a mortgage, the mortgage lender requires you to also buy Private Mortgage Insurance or PMI. PMI is the lender’s way of protecting itself from the risk that you might fail to pay back the mortgage – if you default on the loan, the issuer of the PMI policy will pay the lender most or all of the outstanding balance.
The cost of a PMI policy customarily depends upon the amount of the mortgage and can vary widely – anywhere from $30 to $100 per $100,000 borrowed. Although the lender is the beneficiary of the PMI policy, the borrower is required to pay the premiums. The premiums are usually added to your monthly mortgage payment, although you may be given the option of paying a lump sum at closing.
Generally, PMI is required by a lender if the down payment is less than 20% of the appraised value. You can avoid having to pay any PMI by putting down 20% or more of the value when you buy the house. Other possible ways to avoid paying PMI include accepting a higher interest rate on your mortgage or taking out an 80-10-10 loan, in which you put down 10% of the appraised value, take out a first mortgage for 80% of the value, and a second mortgage with a higher interest rate for the final 10% of the value (some lenders also offer 80-15-5 loans, in which borrowers only put down 5% of the appraised value). One advantage of taking out a second mortgage is that the interest may be tax deductible while PMI premiums may not be deductible.
But suppose you don’t have a down payment that large, and the lender requires you to pay PMI when you take out the mortgage. Does that mean you have to pay PMI for the life of the loan?
Thankfully, the answer is no.
Legally, unless otherwise provided for by state law, lenders must cancel a PMI policy when the mortgage balance is scheduled to reach 78% of the appraised value at the time the mortgage was issued, if the mortgage payments are current. In other words, even if you make extra principal payments and pay down your mortgage balance faster than the original amortization schedule, the lender is not required to cancel the PMI policy earlier than the original date that the balance was scheduled to reach 78%.
However, you don’t have to wait for your lender to automatically cancel your policy. Once the balance on your mortgage has reached 80% of the original appraised value, you can ask your lender to cancel the policy. You lender is not required to grant your request, and some mortgages, including FHA loans, do not allow you to cancel PMI early. But if early cancellation is allowed, your lender is more likely to grant your request if you have made timely payments and home values in your area have remained steady or increased since you took out your mortgage.
You can also request cancellation of the PMI policy if you believe the value of your home has increased, and consequently you now have more than 20% equity in your home, even if the balance on your mortgage has still not reached 80% of the original appraised amount. You will likely be required to pay for a new appraisal. But a lender is more likely to reject your request in this case, even if you have a stellar payment history and home values have remained steady.
In this situation, your best course of action may be to refinance your mortgage. The refinance process will require a new appraisal, and if the new numbers show that you now have 20% or greater equity in your home, PMI will not be required on your new mortgage. Before you choose to refinance your mortgage, however, you should consider all of the factors related to a refinance to decide if it’s the right move overall.