Bye-bye PMI

HOW TO AVOID OR GET RID OF PRIVATE MORTGAGE INSURANCE

You’ve been saving up every penny to purchase a home. Interest rates are enticingly low, and you’d like to pull the trigger soon — before home prices rise any further. But there’s an extra cost you may not be aware of that could apply to your loan: private mortgage insurance (PMI), which could increase your monthly payments by hundreds of dollars, depending on the terms of your loan.

Mortgage lenders like it when borrowers have “skin in the game” in the form of a substantial down payment. If you have less than 20 percent of the purchase price to put down on a conventional mortgage or refi, the lender sees this as an increased risk. So they require you to pay PMI, which serves as an insurance policy for the lender in case you can’t make your payments and default on the loan.

“PMI is applied when your loan-to-value (LTV) ratio is greater than 80 percent,” explains Eric Jeanette, president of Dream Home Financing and FHA Lenders. The LTV ratio is a metric that demonstrates the size of your loan versus the value of the home. LTV is determined by dividing the loan amount into the home’s total value. If your desired property costs $300,000, and you have $40,000 saved for the down payment, you’d need to borrow $260,000; $260,000 ÷ $300,000 = 86.7 percent. In this scenario, you’d need to pay

PMI to get a mortgage on this property.

If you are interested in purchasing a home with an FHA mortgage loan, this insurance is called MIP (mortgage insurance premium). FHA loans with an LTV between 70 percent and 90 percent require MIP to be paid for 11 years; if your LTV is over 90 percent, you’ll pay MIP for the entire life of the loan and can’t get it removed.

Make no mistake: whether it’s PMI or MIP, the expenses add up quickly. PMI often costs between 0.5 percent to 1.5 percent of the loan’s total amount, broken up into monthly payments attached to the monthly mortgage amount you pay. This is a big reason why many borrowers want to avoid PMI/MIP in the first place or get it removed relatively soon after buying a home.

“Eliminating PMI for my mortgage allowed me to save $260 per month. This gave me substantially more cash flow to invest or spend as I choose,” says Chase Lawson, an Austin, Texas-located personal finance expert and author of “Financial Freedom: Breaking the Chains to Independence and Creating Massive Wealth” (Amazon, 2019).

To get PMI removed automatically, you have to wait until your LTV reaches 78 percent; that means making regular payments for several years. But if you don’t want to wait that long, you have options. First, if you’ve not yet closed on the mortgage loan, your lender may allow you to pay the full PMI premium at closing.

“Another way to get PMI to drop off early is to pay extra toward your principal in the early years of your loan, which will lower your LTV and increase equity more quickly,” recommends Phil Georgiades, Realtor at FedHome Loan Centers, headquartered in San Diego.

But be forewarned: Some lenders may require you to submit a PMI cancellation request in writing once your LTV has dipped below 80 percent, Jeanette notes.

“Also, PMI typically cannot be removed in the first two years of the loan, unless you made improvements to the property,” Lawson adds. “After two years and before five years, in order to remove PMI, your LTV must be 75 percent or less; after five years, the LTV requirement moves to 80 percent.”

An additional strategy for nixing mortgage insurance is to refinance your conventional or FHA loan into a new conventional (non-FHA) loan in which you put 20 percent down. However, refinancing comes with a price: You’ll have to pay for a new appraisal and closing costs. And it doesn’t make sense to refinance anyway unless you can lower your interest rate and/or the length of your loan.

“There is a risk that your home will not appraise at a high enough value in which case you’ll be out the cost of the appraisal and still stuck with PMI,” cautions Lawson.

If you haven’t yet closed on your original mortgage loan, review the fine print carefully.

“Always establish what the lender’s guidelines are to remove PMI before you sign the closing documents. Once you understand the rules, then you can develop a plan to eventually remove PMI,” Jeanette advises.

Lastly, if the lender offers a “lender-paid PMI” option, know what you’re getting into.

“If a lender is advertising no PMI, they are probably giving you a higher interest rate to compensate for it. In this scenario, it could be cheaper to pay the PMI yourself,” Georgiades says.

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