Private mortgage insurance payments don’t have to last forever
How to stop paying for private mortgage insurance
- You can request to stop paying PMI when you reach 20 percent equity in your home.
- PMI is automatically canceled on conventional loans after reaching 22 percent equity.
- FHA loans work differently — you may have to pay mortgage insurance for the life of the loan.
- Refinancing out of an FHA loan and into a conventional loan can help you avoid mortgage insurance payments.
Most homeowners who have a home loan have likely heard the phrase “private mortgage insurance,” especially if their down payment was less than 20 percent of the purchase price.
Private mortgage insurance, or PMI, is required on the vast majority of mortgages where the loan-to-value (LTV) ratio is greater than 80 percent, meaning the homeowner has less than 20 percent equity in the home. PMI is a way for lenders to mitigate risk as they are compensated in cases of default or foreclosure.
The bulk of today’s home mortgages are conventional loans sold to and serviced by government-sponsored enterprises Fannie Mae or Freddie Mac. These are also known as conforming loans. Other conventional loans are considered nonconforming or jumbo loans because they exceed the GSE size limits. There are other conventional loans that a lender keeps on their own books, also known as portfolio loans. And many others are government-backed loans guaranteed by the Federal Housing Administration (FHA).
In each of these cases, a borrower who has less than 20 percent equity in their home is required to pay PMI. The costs vary and depend upon your LTV ratio, Freddie Mac’s website states, but typically run between 0.5 percent and 1.5 percent annually. For example, if you borrow $250,000 and your PMI rate is 1 percent, you’ll pay $2,500 per year, or $208.33 per month.
If you have a mortgage backed by the U.S. Department of Agriculture (USDA), you’ll pay a smaller PMI fee. The USDA’s guaranteed loan program charges an upfront fee of 1 percent of the purchase price, plus an annual fee of 0.35 percent. This fee applies to both purchase and refinance loans.
Another popular home-loan program, administered through the U.S. Department of Veterans Affairs (VA), does not have PMI requirements. However, the VA typically charges borrowers an upfront “funding fee” that is rolled into their monthly payment. This fee generally ranges from 1.25 percent to 3.3 percent of the purchase price, depending on the size of the downpayment.
The big question, then, is when can a homeowner stop paying PMI? The answer can be a bit complicated and hinges on the type of loan you have.
How does mortgage insurance work on conventional loans?
For conventional loans, the magic number is 78. Mortgage servicers are required to cancel PMI when your LTV ratio is 78 percent. This applies to all conforming loans purchased by Fannie Mae or Freddie Mac, jumbo loans that exceed the GSE size limits, as well as portfolio loans.
Additionally, the Homeowners Protection Act allows borrowers to request PMI cancellation when their LTV reaches 80 percent. The Consumer Financial Protection Bureau (CFPB) says that mortgage lenders, upon closing, should disclose a date when your LTV will reach 80 percent, assuming you make your payments on time. If you’ve made additional payments, you should contact your servicer to find out when you’ll cross the 80 percent threshold.
If you’re requesting early termination, lenders may require an appraisal, at your own expense, to verify that the home’s value hasn’t decreased. You may also request early termination if you can verify that your home’s value has increased, particularly if you’ve made improvements. You’ll need a good track record of on-time payments to qualify for early termination.
That 2 percent difference in LTV ratios can be sizable. For example, if your home is worth $300,000, you may qualify for early termination when your loan balance reaches $240,000, or 80 percent LTV. If you wait for the LTV to hit 78 percent, however, the balance will need to be $234,000. That $6,000 difference could cost you an extra $810, based on a monthly PMI payment of $67.50.
How does mortgage insurance work on FHA loans?
The terminology for FHA loans is slightly different as they include a mortgage insurance premium, or MIP, but the purpose is the same.
If you applied for an FHA loan on or after June 3, 2013, you’ll be paying MIP for 11 years. However, if your loan balance started with an LTV rate of 90 percent or higher, meaning your down payment was 10 percent or less, MIP is required for the life of the loan. FHA loans include an upfront premium of 1.75 percent of the loan amount, and the annual premium ranges from 0.45 percent to 1.05 percent.
The rules are different for older loans. If your FHA loan was originated prior to 2001, you’ll pay MIP for the life of the loan. For loans originated between Jan. 1, 2001, and June 2, 2013, the premium is lifted when you meet three conditions — your LTV is 78 percent of the home’s original value; you’ve paid MIP for at least five years; and you haven’t accrued any 30-day late payments for the past 12 months.
If you’re looking to avoid long-term insurance premiums, refinancing out of an FHA loan and into a conventional loan may be your best bet. You’re eligible if you have at least 20 percent equity in your home. Keep in mind, however, that conventional loans may have more stringent qualification standards, such as higher credit scores, and refinancing typically includes significant closing costs that will require you to either have cash on hand or make higher monthly payments by rolling the closing costs into the loan.